Buy The Dip In U.S. Bank Stocks

The dip in U.S. bank stocks caused by narrowing net interest margins is a buying opportunity.

Buy The Dip in US Bank Stocks

R egional bank stocks sold off following third quarter profit results. Lower mortgage rates and the pick-up in prepayments have pressured net interest margins, while litigation costs and debt valuation adjustments also weighed on profits. But according to our U.S. Equity Strategy service, the earnings outlook remains encouraging, despite the compression in net interest margins.

Even a gradual recovery in housing has allowed overall bank lending to broaden beyond C&I loans, as residential mortgage origination is accelerating, albeit from a low level. Banks are able to originate long-term fixed mortgages and then offload them in the secondary market at better rates, locking in a tidy profit. This spread is near its highest level since the mid-1980s.

Bank lending is clearly highly correlated with bank earnings growth.

The implication is that evidence of increased lending volumes should be viewed as a critical positive earnings driver, despite the squeeze on net interest margins. Also, overall employment is climbing much faster than bank employment. This is favorable for relative profits and, by extension, relative share price outperformance.

Importantly, bank loans are climbing much faster than bank headcount, reflecting productivity improvement. With relative valuations still close to rock bottom levels,investors remain unconvinced about the durability of the recovery in bank profitability.

Bottom line: We recommend leaning into this pessimism by adding to overweight positions on the dip in the S&P regional bank index.

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