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2019 Has Been Good for Bank Stocks. How Will 2020 Be?

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The performance of bank stocks has been good in 2019. Despite a few concerns, the KBW Nasdaq Bank Index has rallied 29.7% so far in 2019 and the SPDR KBW Regional Banking KRE index has risen 22.7%. The S&P 500 Index rallied 27.2% during the same period.

The year 2019 saw three interest rate cuts, in July, September and October, after the central bank had raised rates four times last year. In fact, it has almost been a decade since the Fed has reduced rates.

We are all aware that banks thrive in a rising rate environment. The interest rate cuts this year placed banks in a disadvantageous position. Almost all big and small banks, including JPMorgan JPM, Bank of America BAC, PNC Financial PNC, Zions Bancorporation (ZION - Free Report) and others, get adversely impacted by lower interest rates.

Banks seek to borrow money at short-term rates and lend at long-term rates. As interest rates decline, the companies earn less on lending, which compresses their net interest margin (NIM) — the main indicator of a bank’s profitability.

Nevertheless, the U.S. economy has been growing at a decent pace defying market expectation of slowdown at the beginning of the year, which supported the performance of bank stocks this year. Per the Fed officials, the economy is expected to grow at the rate of 2.2% in 2019 and 2% in 2020.

The performance of bank stocks was also driven by benefits from easing of regulations, lower tax rates and efforts to expand inorganically. In one of the biggest banking deals in a decade, BB&T Corp acquired SunTrust Banks to form the sixth largest bank (in terms of assets) in the United States – Truist Financial TFC. Moreover, the second half of 2019 witnessed a decline in mortgage rates, which helped improve mortgage lending. This positively impacted banks’ mortgage revenues to an extent.

After a good 2019, banks are expected to continue benefiting in 2020.

After cutting rates thrice this year, the Fed announced no changes in interest rates at the Federal Open Market Committee (FOMC) Meeting earlier this month. The benchmark federal funds rate, thus, remained unchanged at 1.50-1.75%.

Also, supported by a strengthening economy, optimism on reaching the inflation target and impressive labor-market gains, the Fed has signaled that there will be no more rate changes throughout 2020. This is good news for banks and will likely support NIM growth.

Further, while banks’ efforts to upgrade technology at ATMs and branches to make them more client friendly are likely to result in higher expenses in the near term, these are expected to support financials.

Moreover, banks are foraying into new avenues to improve revenue mix. With loan demand being moderate, banks are focusing more on generating fee income. This will likely enable banks to be less dependent on interest rates. Also, they are opening branches in new markets, which will support cross-selling opportunities.

Additionally, the recent positive developments related to the trade war and strong probability of Brexit within Jan 31, 2020, are matters that are likely to be catalysts for banks in 2020.

Also, driven by the positive developments, the yield curve has started to become steep, after becoming flatten/inverted during the beginning of 2019. Thus, banks are likely to gain from higher market interest rates as widening spread is expected to support NIM.

Thus, it can be said that bank stocks’ rally will continue in 2020.

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