Bank stocks in focus with rising yields and interest rate hikes in sight

No one is more excited at the prospect of banks recovering than bank robbers. In 2020, shrinking profits had the banking sector’s stock prices trailing the broader market – but last week’s Fed meeting might give banks the boost they need to catch up.

Banks are loanly

Banks had a rough 2020 with profit hits from the pandemic:

• The demand for loans – which drives banking profits – has been low with consumers and businesses hesitant to borrow.
• The Fed lowered interest rates to promote spending – which meant lower profits on bank loans.

It got so bad that the average net interest margin, which measures lending profitability for banks, reached a record low of 2.5% in the second quarter – a full percentage point lower than in 2019.

As a result, bank stocks began to look cheap on a price-to-earnings ratio basis relative to the broader market. This is good news for investors looking for cheaper sectors with the future looking bright for banking.

Brighter days: The Fed has spoken

Banks mergers were at the lowest level since 2015 last year over fears of loan defaults – but 2021 tells a different story:

• Banks announced $54b in mergers so far this year, on pace for the highest level since 2008.
• This indicates that banks are in a better financial position (and able to take on more risk) than they were last year.

Mergers aren’t the only sign that banks are recovering. Last week, the Federal Reserve announced plans to reverse its pandemic stimulus programs in November – suggesting a stabilizing economy.

The good news doesn’t end there. More signs point to higher bank profitability:

• 9 of the 18 officials at the Fed meeting projected rates to rise in 2022, compared to 7 in July’s meeting.
• 10-year Treasury rates hit their highest level since July on Friday – which could increase banks’ loan profits.

Investors: Bank boom incoming?

News of potential interest rate hikes in 2022 had an immediate impact on the market:

• The KBW bank index (INDEXNASDAQ:BKX), which tracks the 24 biggest banking stocks in the US, is up 7% since the news.
• All 24 members of the bank index are up over 2.5% since the meeting, with nearly half gaining over 10%.

The Fed doesn’t meet again until November, but the next catalyst for banking stocks is likely closer than that – as banks kick-off their earnings report in the second week of October – giving investors a better look at their post-pandemic recovery.