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Strong earnings are expected, but shares may need more than that to halt slump
By Rachel Louise Ensign
This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (July 12, 2018).
Big banks are expected to report another quarter of strong profits starting Friday. But that might not be enough to get skittish investors interested in bank stocks again.
A broad index of big bank stocks is roughly flat since the start of the year, lagging behind the 3.8% gain of the S&P 500. Shares of major lenders including Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. have performed even worse and are in the red for 2018. That marks a big shift in sentiment from the period between the 2016 presidential election and the end of 2017, when the KBW Nasdaq Bank index rose 42%, outpacing the broader market.
Smaller bank stocks have done somewhat better in 2018, lifted by the prospect of mergers in this part of the market where buyers pay a premium, according to Keefe, Bruyette & Woods Inc. analyst Christopher McGratty.
Since earnings are projected to be higher than in years past, while share prices have stayed flat or declined, the big four U.S. banks now trade at lower price/earnings valuations. "Sentiment doesn't seem too positive," Bernstein analyst John McDonald wrote this week, citing investor concerns that the end of the economic expansion is near and bank earnings are peaking. Still, he wrote, it is likely "the good times could also continue for a while."
Investors have grown wary of bank stocks, analysts say, because of a bond-market development known as the flattening of the yield curve: a narrowing of the difference in the yields of shorter- and longer-term Treasurys.
A flatter yield curve can be bad for banks because they earn less on loans and securities tied to longer-term Treasurys. The narrowing also potentially signals problems ahead for the economy.
But some analysts think worries about the yield curve and the subsequent retreat from bank stocks is overblown. That is because bank-lending profits are often more closely tied to differences in measures of short-term rates rather than short- and long-term ones. For example, many loans to businesses are pegged to the London interbank offered rate, or Libor. That metric has risen far more than the amount banks are paying to money-market depositors, boosting lending profits.
Roughly two-thirds of bank exposures price off the short end of the yield curve, Goldman Sachs Group Inc. analysts noted in a report this week. Because of this, they added, worries about the flattening yield curve are "largely overstated for bank earnings."
Meanwhile, broader loan growth, a major factor in profitability, has started ticking back up after a long decline that began in 2016.
Especially important, business lending has shown signs of a resurgence in recent months after a two-year slowdown in growth.
A catch is that commercial real-estate lending growth, which many banks relied on as a major source of new loans, has continued to decline. Bank executives have warned of potential credit issues in this area for years, but those have yet to materialize.
Additionally, mortgages remain a concern. As interest rates continue to rise, mortgage originations are expected to fall due to a shop drop-off in refinancing activity. That is expected to hit lending growth as well as noninterest income.
Despite such concerns, most analysts are fairly upbeat about banks' coming earnings reports. They expect firms to at least meet market expectations, which could bolster share prices that have been pricing in a more dire outlook.
Write to Rachel Louise Ensign at email@example.com
(END) Dow Jones Newswires
July 12, 2018 02:47 ET (06:47 GMT)
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