Yahoo Finance

For Immediate Release

Chicago, IL – April 05, 2016 – Today, Zacks Equity Research discusses the U.S. Banks, (Part 1), including Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM).

Industry: U.S. Banks, Part 1

Link: https://www.zacks.com/commentary/77103/us-banks-stock-outlook---april-2016

It is being assumed that U.S. banks will rally, as a tradition, when the Fed finally starts raising interest rates. But the linear relationship might not hold true this time around.

Despite consistent earnings performances over the past several quarters as well as the entry into the rate hike cycle, U.S. banks have not been able to draw investors’ attention, as evident by the poor performance of the KBW Nasdaq Bank Index (BKX) so far in 2016. The index, which typically thrives in a rising rate environment, has been underperforming the S&P 500 despite a rate hike in December and the possibility of a sequence of hikes (at least two this year). This indicates that investors are not hopeful about the sector’s ability to capitalize on this opportunity. But why?

Cheap money for a prolonged period and the resultant deflationary pressure, slump in crude oil prices, collapse of commodity prices and global economic threats may have altered the traditional relationship between bank stocks and interest rates.

Though banks might fail to keep the tradition of rallying into a new rate hike cycle this time around, their performance may not be as bad as it was during the drawn-out low-rate environment.

Rising interest rates will not only lift banks’ bottom lines through spread expansion, but will also help them earn incrementally from the money they need to keep at the Fed.

Further, supportive macroeconomic elements will minimize default rates on loans. Banks will also see increased demand for mortgage loans, car loans and other consumer loans with improving economic conditions.

However, the industry’s success trail since the last financial crisis hasn’t been consistent due to the nonstop cropping up of issues. And banks are not expected to be relieved of them any time soon. Along with the ramifications of past wrongdoings, a host of new issues -- cybercrime, regulatory compliance and unconventional competition, to name a few -- have been denting their financials and will continue doing so. But a sharper focus on reducing needless expenses by reorganizing business, and an increased focus on revenues to boost bottom line are gradually making the growth path steadier.

Further, the benefit from reserve releases is gradually fading with a significant run down of reserves for the majority of banks. Banks had to resort to reserve releases in the last several years in order to offset the effects of weak demand and an ultra-low interest rate environment. But with the prospects of improving demand and rate hike cycle, banks will not have to tap into the fund that they set aside for covering bad loans. This will help them to shield their business against downturns.

We’re standing on the threshold of a new rate hike cycle, and speculation of its impact – though not immediate – is rife. Perhaps a look at what’s characterizing the industry now will help in understanding its prospects. So here are the industry’s key trends:

Mortgage Business: The past few years were tough for banks’ mortgage business due to a strict regulatory environment. While a low-rate environment encouraged people to refinance home loans, commercial banks witnessed sharply declining fresh originations. Further, low margin on fresh mortgages due to low rates and a rise in nonbank lenders made mortgage business miserable.