Wall Street banks have shown over the past 18 months that they can thrive in good times and bad times. Their traders have benefited from spikes in trading volume during chaotic times. When the economy was struggling, bankers collected commissions for helping businesses raise funds. As the economic recovery takes hold, the same bankers are advising companies looking to go public or make acquisitions.
The third trimester will be no different. Strong investment banking income is expected to compensate for the slowdown again after the pandemic-era business boom. Expect more loan loss reserves to be released to support earnings, but less than in the previous two quarters. Big banks are expected to achieve a 20% year-on-year increase in earnings per share, analysts at Wells Fargo believe.
Still, markets have already factored in expectations of strong earnings in the third quarter. The KBW Bank Index has climbed 72% in the past 12 months, well ahead of the S&P 500’s 28%. Morgan Stanley and Goldman Sachs – the two largest independent investment banks on Wall Street – have done even better, roughly doubling their value. At around 1.9 times the tangible pounds, the sector is trading close to five-year highs.
Investors may well ignore the earnings figures, as the banks are reporting this week. Instead, they should focus on loan growth and any direction for the business on its future trajectory.
Major U.S. lenders saw their loan portfolios shrink in 2020 for the first time in more than a decade, as Americans used stimulus funds to pay off debt and corporations issued bonds instead of taking loans .
Credit activity has remained depressed this year. Weighted average loan growth at large-cap banks fell 7% in the second quarter and is expected to decline another 2% year-on-year in the third quarter, according to Morgan Stanley.
For banks, which are inundated with deposits, the lack of lending opportunities reduces net interest margins. These fell to an all-time high of 2.5 percent during the second trimester.
Some may argue that trading and investment banking income has peaked. Yet banks still have room to increase profitability the old-fashioned way, the traditional bank. Citigroup stands out as the most affordable bank stock because it trades at 0.8 times its book value, the lowest multiple among the six mega-banks. Any sign that loan growth has reached an inflection point should provide it and other retail banks with a catalyst for a further rise in the share price.
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