These two bank stocks shine as the industry gets closer to turning a corner

Banks have suffered during the Federal Reserve’s cycle of raising interest rates to combat inflation, because their funding costs have risen more quickly than their interest income on loans and investments. The yield curve remains inverted, with the federal-funds rate in a target range of 5.25% to 5.50%, the yield on 3-month U.S. Treasury bills
BX:TMUBMUSD03M
at about 5.40% and the yield on 10-year Treasury notes
BX:TMUBMUSD10Y
at about 4.04%. The 10-year yield has declined from 4.84% on Oct. 27, which was when the S&P 500
SPX
declined to its closing low for the second half of 2023. This indicates bond investors expect short-term rates to decline significantly.

The Fed’s own economic projections anticipate three cuts to the federal-funds rate this year, and the buzz at fourth-quarter financial industry conferences was that banks’ net interest margins (the spread between their average yield on loans and securities investments and their average cost for deposits and wholesale borrowings) will “trough during the first half of 2024, and then will begin to increase through 2025,” according to Macrae Sykes, who manages the Gabelli Financial Services Opportunities ETF
GABF.

During an interview with MarketWatch, Sykes called that a “good setup” for bank stocks.

In his banking industry earnings preview on Jan. 3, Wedbush analyst David Chiaverini wrote of a “clearer line of sight” to a bottoming of net interest margins, which he expects to have occurred in the fourth quarter or to happen during the first quarter “for most banks.”

As usual, the stock market has anticipated the improvement while also taking comfort that banks’ bondholdings would increase in value as long-term yields fell. Here’s how the Invesco KBW Bank ETF
KBWB,
the KBW Regional Banking ETF
KBWR
and the SPDR S&P 500 ETF Trust
SPY
have performed since Oct. 27, with dividends reinvested.

What analysts expect for big banks’ net interest income

Here are consensus estimates for fourth-quarter net interest income (interest received from loans and investments less interest paid on deposits and wholesale borrowings) among analysts polled by FactSet for the 20 largest U.S. banks, sorted by Sept. 30 total assets. Figures are in millions of dollars.

Among the largest 20 U.S. banks, Only JPMorgan Chase and Capital One Financial Corp.
COF,
+1.46%
are expected to show sequential and year-over-year increases in net interest income.

For Goldman and Morgan Stanley, which are focused more on investment banking and asset management, changes in net interest income will have a limited effect on overall profits. The same can be said for Bank of New York Mellon Corp.
BK,
+0.56%
and State Street Corp.
STT,
+0.59%,
which focus on securities custody services, wealth management and asset management.

The bottom line: EPS estimates

Despite investors’ recent enthusiasm for bank stocks, Odeon Capital Group analyst Dick Bove believes fourth-quarter industry results are “likely to be ignored” because reported numbers “will show that the banking industry is dealing with significant change,” and reflect many one-time events, he wrote in a note to clients on Jan. 4.

One-time events Bove expects to distort earnings results will include some realized losses for banks that make substantial changes to their bondholdings to shed some lower-paying investments and restructuring associated with the implementation of Basel III regulatory capital rules. He also expects a bump in loan loss reserve set-asides to cover an expected increase in defaults by borrowers.

Here are consensus fourth-quarter EPS estimates for the largest 20 U.S. banks, compared with results for the previous four quarters:

No sugarcoating: A dismal fourth-quarter is expected by analysts, not only reflecting the one-timers cited by Bove but the subdued market for investment banking during 2023.

Among the largest 20 banks, only Charles Schwab Corp.
SCHW,
+0.94%
is expected to show a sequential improvement in quarterly EPS, and only Wells Fargo, Goldman, U.S. Bancorp
USB,
+0.65%,
Bank of New York Mellon and American Express Co.
AXP,
+0.77%
are expected to show year-over-year increases.

Investors in the stock market have clearly been looking way beyond a kitchen-sink fourth quarter.

Analysts’ opinions

Leaving the 20 largest banks in the same order, here’s a summary of opinion among analysts working for brokerage firms polled by FactSet:

Click on the tickers for more about each company.

Click here for Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.

From the price targets, it appears the analysts see the group as being close to fully valued — even the stocks with majority “buy” or equivalent ratings. Then again, analysts working for brokerage firms tend to set 12-month price targets. Investors may be looking further out.

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