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Bank Stocks and the Business Cycle

2000; American Bankers Association; Volume: 92; Issue: 4 Linguagem: Inglês

0194-5947

Kelly K. Matthews,

Credit Risk and Financial Regulations

To moderate the volatile business-cycle influence on earnings, many banks have recently developed new tools to measure and manage revenue and profit growth. In 1999, bank-stock valuations dropped below 50% of the average S&P 500 price/earnings multiple. The recent, serious erosion in bank-stock prices may be prolonged as investors anticipate further tightening actions by the Federal Reserve and rising credit-quality costs. Despite strong earnings in 1999, the relative multiple deterioration seems to attach the following banking outcomes to current monetary policy intentions and expected 2000 business-cycle developments: 1. Rising short-term interest rates will further flatten the yield curve, compressing the spread between cost of funds and earning-asset yield. 2. A slower-growth economy will intensify competitive pressures and narrow earning-asset gains. 3. Higher credit-quality costs may necessitate enhanced reserves. Recent research by Banc of America Securities suggests bank stocks do not consistently under-perform during periods of interest-rate increases. Nevertheless, aggregate banking data do demonstrate a cyclical impact on bank earnings performance. For example, in the early 1990s during the business cycle's recovery phase, the banks with the most noticeably improved earnings per share were often the lowest ROA companies. The abrupt interest-rate decline in 1990 and 1991 appreciably widened the industry's average net-interest margin, leading to accelerated bank asset growth and reduced credit-quality losses. By 1997, however, the cyclical sources of banking earnings growth were essentially used up. Over the past three years, the primary source of earnings expansion was revenue growth, most successfully achieved by already high-performing banks. In contrast with the cyclical sources of profitability--which tend to be self-extinguishing--favorable revenue growth, while protecting credit quality, has the potential to be ongoing and sustainable. In the economic environment anticipated for 2000, maintaining improved revenue growth while avoiding credit deterioration will be a challenging business model--even for high-performing banks. In some instances, investment necessary to generate new revenues, and thereby greater profitability, has been delayed because expense reduction has become the highest priority. In the final analysis, ongoing revenue gains are closely related to value-added customer products and services, complemented by a comprehensive, systematic pricing policy that encompasses capital management. …