Following a rough week for the market, bank stocks helped pivot the narrative positively through better-than-expected earnings performances. Mainly, the prevailing theme centered on net interest income as the financial sector benefitted from higher interest rates. However, akin to the classic Twilight Zone episode, “To Serve Man,” investors should read the fine print.
On paper, circumstances look encouraging for bank stocks. According to a Bloomberg report, Bank of America (NYSE:BAC) disclosed its “highest quarterly net interest income in at least a decade as the lender reaps the benefits of the Federal Reserve’s interest-rate hikes, and debt traders beat analysts’ estimates.”
Specifically, net interest income jumped 24% in the third quarter on higher rates and loan growth. Prior to the disclosure, analysts anticipated about a 23% increase in net interest income. In early afternoon trading, BAC gained 5.7%, one of the top performers among bank stocks.
As well, Bank of New York Mellon (NYSE:BK) joined in on the fun and delivered another solid performance for bank stocks. Prior to its disclosure, Wall Street anticipated the company’s earnings to rise “more than 5% to $1.10 per share on 4.2% revenue growth, to $4.2 billion,” per Investor’s Business Daily. Instead, “BNY Mellon’s adjusted earnings jumped to $1.21 per share while revenue rose to $4.28 billion.” BK stock’s price has risen more than 4.8% today.
Additionally, Charles Schwab (NYSE:SCHW) posted its strongest quarterly performance in company history. According to CFO Peter Crawford, “Net interest revenue increased by 44% to $2.9 billion, as rising rates helped our net interest margin to expand sequentially by 35 basis points to 1.97%.” However, SCHW stock has slipped 4.9% today, possibly due to total client assets declining 13% to $6.6 trillion.
Bank Stocks Face Longer-Term Concerns
Although the rise in net interest income seemingly bodes well for bank stocks, investors must look carefully to the future. Given the leverage backdrop heading into the pandemic-fueled new normal, the Fed’s pivot toward a hawkish monetary policy may yield sharp consequences.
First, data from the Board of Governors of the Federal Reserve System noted that the ratio of debt to assets for all publicly traded nonfinancial firms “was at its highest level in 20 years at the beginning of 2020.” Moreover, for highly leveraged public firms, this indicator was close to a record high.
Later on, though, the devastation of the Covid-19 pandemic and the Fed’s monetary easing at the time contributed to a rash of corporate borrowing. However, with the Fed now tightening the money supply, this behavior will likely diminish. In turn, the economy may eventually see a reduction in business activity, which would be negative for bank stocks.
Indeed, a June report earlier this year by Barron’s essentially sounded the alarm. By raising the benchmark interest rate, this dynamic incentivized “less borrowing by companies, a lot less.” It was Bank of America that reported not a single company borrowed money in the first half of the week starting June 12.
While Wall Street celebrates bank stocks right now, it’s important for investors to realize that these very same institutions disclosed the damage done by the Fed’s higher rates. Therefore, vigilance remains a key attribute during these uncertain times.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
