Banks Lag S&P as Slow Loan Growth Eclipses Higher Dividends

Bank stocks are underperforming the Standard & Poor’s 500 Index, even after Federal Reserve stress tests showed some financial institutions have regained enough strength to boost dividends and buy back their shares.

Sluggish loan growth and increased costs from new regulations plague the industry, according to Paul Miller, a former examiner for the Fed Bank of Philadelphia and a bank analyst at FBR Capital Markets in Arlington, Virginia. He maintains a “neutral-to-negative” outlook for the sector.

“I don’t think we’ll get enough economic growth to spur strong loan demand, which is the primary revenue-driver,” he said. “Some investors are concerned the economy will just slug around for the next three or four more years.”

The Financial Select Sector SPDR Fund (XLF), an exchange-traded fund that tracks the largest financial companies, has lagged behind the S&P 500 since April 14, 2010, off 15.7 percent as of 10:30 a.m. today in New York Stock Exchange composite trading, hitting a new 52-week low on a relative basis.

The fund outpaced the S&P 500 by 1.2 percent on March 18, when at least 13 lenders announced whether they had passed the tests and disclosed about $17.7 billion in common-stock buybacks and $5.94 billion of annualized dividend increases. The gain was nearly reversed the following trading day, as the ETF underperformed the S&P by 1.1 percent. Since March 18, it has trailed by 5.6 percent as of 10:30 a.m., even though the tests provided “generally encouraging results” for shareholders, said Jason Goldberg, a senior analyst at Barclays Capital in New York.

‘Positive Catalyst’

“We had expected the Fed’s review to be more of a positive catalyst for bank stocks, but investors are more concerned with disappointing revenue growth, driven by weak loan activity and falling house prices,” Goldberg said.

Bank lending rose 0.9 percent in the fourth quarter of 2010 from the third quarter, below the historical average of 2 percent for October-December, based on Fed data. Goldberg projects the total fell 3 percent in the first quarter from the fourth; the average for the period is a 0.7 percent increase.

Prices for existing houses fell for eight consecutive months before rising by 2.3 percent in March, according to the National Association of Realtors in Chicago.

These are symptoms of an economy that’s “not able to sustain much accelerated forward momentum,” according to Steven Ricchiuto, chief economist at Mizuho Securities in New York. He forecasts the U.S. will expand at an annual rate of 2.5 percent this year, compared with the median forecast of 2.9 percent in a Bloomberg survey of economists, which matches last year’s 2.9 percent pace.

‘Need to Restructure’

“The need to restructure balance sheets by banks and consumers leaves the economy subject to risk,” he said.

Real-estate markets for single-family homes were, “for the most part,” either “little changed from low levels or continued to weaken” across all the Fed’s 12 districts, according to the central bank’s Beige Book report released April 13. Loan demand was “unchanged or up slightly” in most districts, the report said.

The financial ETF has continued to underperform the S&P 500 even after better-than-expected first-quarter results from New York-based JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C), the second and third largest U.S. banks by assets. JPMorgan Chase said April 13 that profits rose to a second straight record; Citigroup announced earnings on April 18 that beat analysts’ estimates.

Fed Rejection

First-quarter net income at Bank of America Corp. (BAC), the largest U.S. lender, fell 36 percent, missing analysts’ forecasts on what Chief Executive Officer Brian T. Moynihan said April 15 were “one-time” charges and as revenue from consumer banking slipped. The Charlotte, North Carolina-based company didn’t receive Fed approval to increase dividend payouts. After the rejection, it announced plans to re-apply for an increase in the second half of this year.

Even though investors may view the industry’s results as “mixed,” most of the financial institutions reporting so far have beaten estimates, which supports Deutsche Bank AG’s “overweight” rating for the sector, according to Bankim Chadha, chief U.S. equity strategist.

“Considerable growth potential exists, particularly as loan growth eventually turns,” Chadha said.

While banks wait for loan volume to rebound, they’re adapting to the new regulations, which include limits on proprietary trading and on the fees they can charge customers. These higher compliance costs exacerbate the economic pressures they already face, Miller said.

“Banks are a macro play, so for them to outperform, investors need more confidence that the economy can grow more than 3 percent,” he said.

To contact the reporters on this story: Anna-Louise Jackson in New York at ajackson36@bloomberg.net; Anthony Feld in New York at afeld2@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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