U.S. Banks Stock Outlook – August 2015

Back-to-back thriving quarters and prospects of a favorable economy place U.S. banks near the trajectory of consistent growth. Albeit an impressive post-crisis journey, the industry’s success trail hasn’t been consistent, with new challenges often dragging on its players’ performances.

Along with the ramifications of past wrongdoings, a host of new issues — cybercrime, regulatory compliance and unconventional competition, to name a few — have been denting the financials. But sharper focus on reducing needless expenses by reorganizing business and a greater role of revenues in boosting the bottom line are gradually making the growth path steadier.

Another catalyst is the impending interest rate hike, which might bring further stability to top-line generation. With the change in the interest rate environment, banks will see easing pressure on net interest margins and better mortgage activity. But this may not act as a significant support immediately because it will take some time for the rates to return to their pre-recession levels.

The biggest benefit is likely to be in the interest rate spread. While lending rates will improve in a higher interest rate environment, deposit rates will not rise much as banks already have excess deposits. Actually, they will not have to compete to maintain the required deposits.

Let’s take a look at the key trends that the industry has been witnessing:

Mortgage Business: With a low rate environment encouraging people to refinance home loans, the industry is seeing an uptick in mortgage activity. While there have been fewer avenues for fresh originations so far, a likely improvement in real estate lending (in particular the residential side) should lift origination volume. But the overall declining trend of outstanding mortgage loans might persist, as the rate of mortgage originations will take a decent time to beat the rate at which mortgage loans have been repaid or charged off.      

Trading Activity: Higher volatility induced by macro events should favor trading activities at U.S. banks. However, the impact of global growth worries on bond yields and currency exchange rates might significantly dampen the benefits. Overall, trading activity is likely to remain subdued, particularly given the cautious steps taken by investors amid uncertainties surrounding the global economy. Even if trading volumes expand, this will have little effect on revenues thanks to customers’ increased preference for electronic trading to save charges.   

While trading revenues don’t generally indicate a bank’s real performance given the unstable nature of this activity, it is a large component of non-interest revenues for some of the major banks including Citigroup Inc. (C - Analyst Report), JPMorgan Chase & Co. (JPM - Analyst Report) and Bank of America Corp. (BAC - Analyst Report).

Investment Banking: With M&A activities and IPOs working in favor, the generation of advisory and underwriting revenues did not slow down. While this trend is expected to continue for some time, the equities division might slip on cautious steps by investors amid global growth concerns. Overall, investment banking might not contribute significantly to total revenues in the quarters ahead.

Loan Volumes: Overall loan growth is expected to improve on greater demand for commercial and real estate loans. Backed by economic recovery, the areas of auto, credit cards and student lending should also lift the fortunes of banks.