The history of rates is relatively clear. The Federal Reserve leads the rate markets up or down. Banks follow. If this pattern holds true, banks are going to start paying a great deal more for money. This will lower their profit margins and reduce their potential earnings growth rates.
Do bank executives see this as a real possibility? Bank of America is a clear example that they do. For years that bank would publish “bubble” charts showing how much money it would make if interest rates were to rise by 1 percent. In its second quarter conference call, bank management stated that it would no longer make these projections. One reason is that the bank’s profit margin, its net interest margin, actually fell in the quarter despite the multiple rate increases put in place by the Fed.
It is now a real possibility that corporate Boards of Directors are likely to waken corporate treasurers from their somnolent state and demand higher returns on their deposits. If this happens, as expected, banks will not benefit from rising interest rates contrary to investor expectations.
From March 1, 2017 to the present, the KBW Bank Index has declined by 2.8 percent while the S&P 500 is up by 3.0 percent. The interest rate dilemma is one reason. Until it is resolved bank stocks are likely to continue to underperform, particularly those in the regional grouping.
Commentary by Richard X. Bove, an equity research analyst at Rafferty Capital Markets and the author of “Guardians of Prosperity: Why America Needs Big Banks” (2013).
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