Tuesday, April 26, 2022

Banking on Earnings

All else equal, tightening Federal Reserve policy tends to be a drag on profits and growth for most businesses—they make interest costs go up and discourage incremental borrowing. Banks are among the few companies that directly benefit from higher benchmark interest rates: their bread and butter business is making loans and collecting interest, after all.

Investors have been waiting for years for Fed rate hikes to boost bank earnings. Now rates are finally going up, but bank stocks haven't benefited. The SPDR S&P Bank exchange-traded fund has lost some 17% over the past three months, versus a 5% decline for the S&P 500. What gives?

Barron's Carleton English explains the puts and takes:

Across the sector, analysts are at a bit of a loss over what exactly to expect from banks in light of the Fed’s promises of bold moves against high inflation on one side, and the war in Ukraine on the other. 

The Fed’s move to lift interest rates should be a boon for net interest income at the banks because that generally widens the gap between what they pay for funds and what they receive from loans. But the recent inversion of the yield curve, with yields on short-term debt above those on long-term securities, has Wall Street worrying about a recession, which obviously benefits no one.

There's also the year-over-year comparison to consider. The first quarter of 2021 was a boom quarter for big banks, with robust investment banking and trading revenues and income. That set a high bar to beat this earnings season.

So, all together, it's a case of the macro versus the micro for banks. Rising rates are good, but Russia-Ukraine risks are bad. A strong consumer is good, but the outlook is less good. And so on.

Carleton has more on the headwinds and tailwinds for banks in 2022, and all the details on what to expect from the bevy of earnings reports over the coming days. Read her full report here.


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