By Christina Rexrode and Michael Rapoport
The big bounce in bond yields following Donald Trump's presidential victory could give bank investors what they have long wanted: bigger profits.
Bank stocks, which took off Wednesday on the theory that Mr. Trump might loosen regulation and spur economic growth, continued to rise. The KBW Nasdaq bank index climbed 3.8% Thursday, hitting a 52-week high during the day. National and regional banks gained across the board, including an increase of more than 7.6% at Wells Fargo & Co. The KBW index is up nearly 9% over the past two days.
Shares were buoyed in part by news the Trump administration would look for a repeal of the Dodd-Frank Act, the postfinancial-crisis regulatory overhaul that has subjected banks to more-stringent rules and higher capital requirements.
Investors also took cheer in higher rates; the yield on the 10-year U.S. Treasury rose above 2.1% Thursday, hitting its highest level since early January. The yield was 1.85% on Tuesday.
Morgan Stanley analysts said an increase of 1 percentage point in rates would add to big banks' per-share earnings by 5.5%.
Meanwhile, the difference between yields on the 10-year and two-year notes, a proxy for the profit banks can make borrowing and lending money, widened to about 1.23 percentage points. That, too, is its highest level since early January.
The increase in rates and that spread, if they persist, portend an improvement in bank profit margins. Those have been squeezed in recent years by the Federal Reserve's near-zero interest-rate policies and quantitative-easing bond purchases. Banks will benefit further if the Fed, as investors expect, again increases short-term rates at its December meeting.
Analysts at Keefe, Bruyette & Woods & Co. estimated that two Fed rate increases would raise their per-share earnings estimates for banks by more than 4% on average.
Among big banks, Bank of America Corp. could be one of the biggest beneficiaries of higher rates. The bank said in its most recent quarterly securities filing that its net banking revenue would increase by $5.3 billion on an annualized basis if short- and long-term rates both moved up by 1 percentage point.
J.P. Morgan Chase & Co. and Citigroup Inc. have said they expect such a move would increase netinterest income by $2.8 billion and $2.1 billion respectively.
Any such gains will take time to flow through to banks' bottom lines. And in the short term, banks could actually feel more pain from the upward move in rates in the form of a massive hit to their investment portfolios.
Banks have been snapping up Treasurys, mortgage securities and other bonds for years, both because they have needed to do something with their growing deposits and because new rules require them to keep a certain amount of their assets fairly liquid.
Over the past three years, for example, deposits at Bank of America have risen more than 13% to $1.23 trillion. The bank's portfolio of debt securities, worth about $301 billion, is up 28% in the same period.
Those investments are theoretically worth less when rates go up so banks mark them down to their market value, which is a hit to the balance sheet and shareholders' equity, although not to profit. Higher rates also cut down on demand for certain services, like mortgage refinancings.
"You would take a one-time hit," said Nomura analyst Steven Chubak, referring to the effect of higher rates on banks' bond portfolios. "But your earnings will improve, all else equal, in perpetuity."
A move up in rates also can require banks to pay more to deposit holders, although firms tend to increase those more slowly. With the rates they are charging borrowers rising at a quicker pace, this allows for an expansion of their profit margins.
"The pros outweigh the cons" of rising rates, said Barclays PLC analyst Jason Goldberg.
For all the good news, much is still unknown about Mr. Trump's plans. And that has some analysts worried bank-stock investors may be overzealous.
Mr. Trump, for example, previously has shown support for reintroducing a form of the Glass-Steagall Act, which could require the big banks to break up. Andwhile the president-elect promised in his victory speech to build "highways, bridges, tunnels, airports, schools [and] hospitals, " such projects would have to get through Congress.
Bank stocks are getting "ahead of themselves," Brian Kleinhanzl, a bank analyst at KBW, wrote in a note to clients. "[We] would be surprised to see a continued strong rally from here."
(END) Dow Jones Newswires
November 11, 2016 02:47 ET (07:47 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.