Small banks rally pauses
but may not be over yet
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[December 03, 2016]
By Sinead Carew and Chuck Mikolajczak
NEW
YORK (Reuters) - The rally in regional U.S. bank stocks that followed
last month's election of Donald Trump may not be over, but investors may
have to wait for policy to take shape for the massive move to extend
further.
The S&P 600 index of small-cap banks has surged more than 20 percent
since Trump's surprise Nov. 8 victory, while their large-cap peers on
the S&P 500 index have jumped over 17 percent.
Investors booked profits on Friday, with the small-cap index down 0.8
percent and the larger banks dropping 1.1 percent.
Smaller lenders could potentially add as much as 40 percent to their
fourth-quarter 2017 earnings if Trump's promises of tax cuts and
regulatory changes materialize, according to Sandler O' Neill analyst
Brad Milsaps.
But Milsaps has not changed his official estimates to reflect this
possibility as he is waiting for confirmation that those policy changes
will happen.
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Trump is scheduled to take office Jan. 20. His Treasury Secretary
nominee, Steven Mnuchin, on Wednesday criticized the Dodd-Frank banking
regulation act saying that it inhibited bank lending, potentially
implying a willingness to try to change regulations to help boost that
revenue source.
"It remains to be seen how much longer the rally can continue until we
see some tangible evidence of changes coming from the administration
that relates to regulations or tax rates," said Milsaps.
Investors are betting that rising long-term interest rates, expected
corporate tax cuts as well as lighter regulation will help banks under a
Trump administration.
Domestic banks have more to gain from policy changes than their
multinational counterparts as lighter regulation should make it easier
for them to grow more quickly and could allow more mergers, according to
investors and analysts.
They could also benefit more from expected tax cuts and they would be
insulated from currency fluctuations.
"There's definitely more opportunity on the regional banking level,"
David Lebovitz, global market strategist at JPMorgan Asset Management.
"When you go down in market capitalization you begin to insulate
yourself from a lot of these external forces. Dollar strengthening is
less of an issue."
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Traders work on the floor of the New York Stock Exchange (NYSE) in
New York City, U.S., December 2, 2016. REUTERS/Brendan McDermid
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Bank profits depend largely on the spread between long- and short-term
rates. The spread between benchmark U.S. 10-year Treasury notes and
2-year Treasuries has widened nearly 30 basis points since the U.S.
presidential election, touching its highest in a year on Thursday.
Adding to upward pressure on yields, the Federal Reserve is expected to
raise overnight U.S. interest rates at its meeting on Dec. 13-14 by 25
basis points, the first hike in nearly a year.
In relation to rising interest rates alone, Keefe, Bruyette & Woods
boosted its operating earnings growth estimates for banks with assets of
$50 billion or lower to 10 percent from 6 percent next year, and to 11
percent from 4 percent in 2018.
"Earnings revisions, having been negative for many years, are beginning
to turn positive, which is a very important step, and they're turning
positive on higher revenues, which is even more important," said KBW
analyst Christopher McGratty. "They don't look cheap but there's a
justifiable path toward the valuations they're at."
The current forward price-to-earnings for the S&P small-cap bank index
stands at 18.4, well above the six-year median of 15 and at its highest
since April 2011.
McGratty also noted that many analysts will likely update their
estimates for 2017 in coming weeks, which would tighten forward P/E
multiples.
(Reporting by Sinead Carew and Chuck Mikolajczak; Editing by Rodrigo
Campos and James Dalgleish)
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