Since the beginning of 2014, the overall operating environment for banks had been quite tough. Nevertheless, banking stocks showed strong resilience and continued to confront challenges valiantly. Despite weakness in mortgage banking and capital market businesses, a modest improvement in investment banking, along with cost-control measures (streamlining operations and job cuts) and balance sheet restructuring, helped banks maintain profitability.
This was further evident from the overall banking stock performance. While the year-to-date gain of S&P 500 (SPX) was nearly 13.5% (as of Dec 22, 2014), S&P 500 Banks (Industry Group) returned 14.1%.
Fundaments at Play
The prevailing low interest rate environment continued to curb net interest margin growth, thereby putting pressure on net interest income. Moreover, given the increased regulatory restrictions, banks found it difficult to generate non-interest income. Consequently, overall revenue growth suffered. Also, several mandatory defensive measures, like maintaining higher capital ratios, are restricting growth.
Additionally, legal costs became the major earnings dampener for big banks such as Bank of America Corp. (BACÂ -Â Analyst Report), JPMorgan Chase & Co. (JPMÂ –Analyst Report), Citigroup Inc. (CÂ -Â Analyst Report) and Wells Fargo & Company (WFCÂ –Analyst Report). Though banks are making efforts to move past their litigation headwinds, we do not expect such expenses to abate soon.
Nevertheless, credit quality — one of the most important performance indicators — kept on improving, backed by low interest rates, which are expected to prevail at least til mid-2015. Further, the banks witnessed improving trends in mortgage refinancing, auto lending and credit cards, which were able to offset lower mortgage demand to some extent. Also, a boom in M&A and IPO activities led to robust investment banking business.
Earnings Performance
Overall earnings performance of banks has been modest. Better-than-expected earnings remained the key driver of their performance, but this was largely attributable to overly conservative estimates.
On a year-over-year basis, performance of Major Banks remained disappointing, with earnings declining 13.6%, 2.7% and 11% for first quarter, second quarter and third quarter, respectively.
Nonetheless, performance of Banks & Thrifts was impressive. Though earnings declined 6.6% year over year in the first quarter, a steady improvement was witnessed over the last two quarters, with respective growth of 8.9% and 18.7%.
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