US banks: loan growth wanted

Wall Street banks have shown over the past 18 months that they can thrive in both good times and bad. Their traders have benefited from spikes in trading volume during chaotic periods. When the economy struggled, bankers earned fees from helping companies raise cash. With economic recovery under way, the same bankers offer advice to companies eager to go public or make acquisitions.

The third quarter will be no different. Strong investment banking revenue should again offset the slowdown after the pandemic-era trading boom. Expect the release of more loan-loss reserves to bolster profits, though less so than in the previous two quarters. Large banks should achieve a 20 per cent year-on-year rise in earnings per share, think Wells Fargo analysts.

Yet markets have already priced in expectations for strong third-quarter earnings. The KBW Bank index has soared 72 per cent over the past 12 months, well ahead of the S&P 500’s 28 per cent. Morgan Stanley and Goldman Sachs — Wall Street’s two biggest standalone investment banks — have done even better, roughly doubling in value. At about 1.9 times tangible book, the sector trades not far off five-year highs.

Investors may well ignore the headline earnings numbers as banks report this week. Instead, they should focus on loan growth and any company guidance on its future trajectory.

Big US lenders saw their loan books shrink in 2020 for the first time in more than a decade as Americans used stimulus money to pay down debt and companies issued bonds instead of taking out loans.

Lending activity has remained depressed this year. Weighted average loan growth across large-cap banks fell 7 per cent in the second quarter and is expected to shrink another 2 per cent year on year in the third quarter, according to Morgan Stanley.

For banks, which are being flooded with deposits, the lack of lending opportunities is squeezing net interest margins. These fell to a record low of 2.5 per cent during the second quarter.

Some may argue that revenues from trading and investment banking have peaked. Yet banks still have room to boost profitability the old fashioned way, traditional banking. Citigroup stands out as the most affordable bank stock as it is trading at 0.8 times its book value, the lowest multiple among the six megabanks. Any signs that loan growth has reached an inflection point should provide it and other retail banks with a catalyst for further share price gain.

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