Wall Street is bullish on bank stocks in 2022

Bank stocks outperformed the broader market in 2021, and analysts see signs that the gains will continue as the Federal Reserve prepares for interest rate hikes next year.

Several risks could derail that outlook, with inflation, slower economic growth, deteriorating credit quality and the omicron variant of COVID-19 among the possible candidates to throw bank stock prices off course.

But the more likely outcome is that the next couple of years will be a “golden era for bank stocks,” UBS analyst Erika Najarian wrote in a recent note to clients, citing likely Fed rate increases and the return of loan growth after a lackluster 2021.

The KBW Nasdaq Bank Index has climbed 37% this year, beating the 29.5% gain in the S&P 500 Index. Smaller bank stocks also fared well, with the ABA NASDAQ Community Bank Index rising about 33%.

Many analysts and investors remain bullish on the sector.

“The set-up into 2022 is quite positive,” said Cheryl Pate, a portfolio manager at Angel Oak Capital Advisors who focuses on financial service companies.

The key reason for analysts’ optimism is their belief that loan growth is in the early stages of a rebound. Banks struggled to build their loan books during the pandemic's earlier stages, as consumers used excess savings to pay down their credit card balances and businesses became more reluctant to tap their credit lines.

But the picture has shifted in recent months, with consumers leading the way by starting to rebuild their card balances. Consumer loans were up by more than 8% year over year in the second week of December, according to Fed data.

Commercial borrowers have been slower to rebuild their loan balances, but bankers reported some improvement this fall.

“We're starting to see, once again, some good momentum out there,” Fifth Third Bancorp Chairman and CEO Greg Carmichael said at a conference in October.

Commercial lending may be particularly strong in the second half of 2022 as supply chain challenges ease, and businesses borrow to replenish their depleted inventories, according to RBC Capital Markets analyst Gerard Cassidy. Some companies will also increase their longer-term capital spending as the economy continues to grow, he predicted in a note to clients.

“We believe the bank group sets up well for another year of outperformance due to expectations of a benign credit environment, higher interest rates and stronger loan growth,” Cassidy wrote.

The Fed is expected to raise short-term interest rates from effectively 0% next year, part of a shift away from unprecedented support of the U.S. economy as inflation spikes. That will help boost banks’ income, since many commercial loans are pegged to short-term interest rates, which will adjust upward as the Fed hikes rates, Angel Oak’s Pate said.

Excess liquidity from depositors will likely dampen pressure to pay more for deposits as rates rise, providing a boost to bank margins, Pate said.

But analysts do see several risks to their mostly sunny forecasts, and they point to the omicron variant as a wild card. Rising case and hospitalization counts could mean “tougher times ahead for the overall economy and bank stocks in the near term,” Compass Point Research & Trading analyst David Rochester wrote in a note to clients, though he still has a positive outlook on the sector.

Then there’s the possibility that inflation proves more sticky than economists hope, even as the Fed tries to combat it. The Consumer Price Index rose 6.8% in November compared with the same month a year earlier, the biggest increase since 1982.

“Inflation is very, very real,” Wells Fargo CEO Charlie Scharf said at a conference this month, noting that prices for supplies across most industries are rising at the same time a tight job market pushes up companies’ wage costs.

Though economists generally do expect inflation to temper, more persistent price increases could eat into consumers’ wallets and make it harder for commercial borrowers to make their loan payments, Pate noted.

For now, banks’ loan books remain pristine, thanks partly to massive fiscal assistance and a Paycheck Protection Program that helped many small businesses survive the early stages of the pandemic. Bankers expect credit quality to deteriorate somewhat next year as the fiscal boost dwindles, but the industry is still upbeat that loan losses will remain relatively low.

“While it’s hard to fathom escaping a global pandemic with minimal realized losses, it seems to be the reality as loss experiences thus far have significantly outperformed expectations,” wrote David Feaster, an analyst at Raymond James. He added that his team has “become increasingly bullish on the banking sector over the past year.”