Under pressure most of 2023 amid surging interest rates and related recession worries, bank stocks steadied some over the summer as lenders' credit quality held strong and the overall financial health of the industry proved durable.
The KBW Nasdaq Bank Index, home to larger banks, was down 20% year to date through Wednesday of this week. But the index was flat when compared with the start of July, signaling some reprieve from the downward pressure that intensified early this year.
The S&P U.S. SmallCap Bank Index, as of Wednesday's close, was also down 20% on the year but up about 5% since the beginning of July trading.
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Indeed, banks on the whole emerged from the second-quarter earnings season profitable and well capitalized. Loan losses were rare, and most executives were optimistic about borrowers' continued ability to make payments, given a strong labor market and continued economic growth heading into the second half of the year.
The Federal Reserve boosted rates 11 times between March 2022 and the midpoint of this year to
But an enduring bank stock rally may have to wait for new catalysts, Nichols said, given the lingering impacts of rising rates on banks' deposit costs. Following the rate hikes, banks have had to pay up to keep deposits. This, in turn, has squeezed their net interest margins — the difference between what they pay for deposits and earn on loans — a key measure of profitability.
What's more, deposit levels came under further pressure amid the immediate aftermath of high-profile regional bank failures last spring.
"We still have more pressure to endure on deposit costs," Nichols said.
Analyst Scott Siefers of Piper Sandler agreed. "This spring's panic thankfully has given way to a much calmer, though still fluid, outlook for the group," he said of banks. But, while "we're hopefully reaching the latter innings," deposit "flows and pricing are still issues."
Banks' collective deposit outflows slowed in the second quarter. But deposits still declined 0.5% from the prior quarter after falling 2.5% sequentially in the first quarter, according to S&P Global Market Intelligence. The cost to hold on to deposits jumped, too. The industry's aggregate cost of deposits rose to 1.78% in the second quarter, an increase of 37 basis points from the previous quarter, the S&P data show.
Margins, by extension, contracted. The industry's median second-quarter NIM fell to 3.40%, down 5 basis points sequentially. That came after a drop of 15 basis points in the first quarter.
Additionally, with rates high and economic uncertainty persisting, loan demand slowed notably in the first half of the year and remains modest relative to last year, said Mike Matousek, head trader at U.S. Global Investors.
"People are less worried but still a little cautious," Matousek said. "And after all these rate hikes, the cost of borrowing is high, and that's going to slow demand no matter what is going on elsewhere in the economy."
Indeed, total loans and leases at banks with $10 billion of assets or less grew by 2.5% in the second quarter. That was up from a 1.3% quarterly increase in the first quarter, according to S&P Global, but it was down from growth of 3% or greater in each quarter of 2022. When lending slows, banks' interest income tapers.
"So that's a headwind for earnings," Matousek said. "And when there are headwinds on earnings, it's hard for stocks to break out. … So we may need more time, or some new driver we can't see just yet, such as declining rates, to spark a rally."
