BANK PROFITS MUST YIELD TO MARKET / THE WALL STREET JOURNAL

Bank Profits Must Yield to Market

Optimism about Wall Street’s earnings power was too strong already. Then this week happened.

By John Carney

Aug. 20, 2015 4:46 p.m. ET

 Bank of America shares slid more than 4% Thursday. Photo: Justin Sullivan/Getty Images


The more optimistic talk among bank investors and analysts over the past year has centered on the potential for rising rates to drive earnings growth. Banks themselves have taken to including estimates of how much additional net interest income they would earn in a hypothetical scenario of rates rising by one percentage point instantaneously.

Forecasts for 2016 earnings generally show that analysts expect net interest income to grow by between 5% and 8% at the biggest banks, according to Sanford C. Bernstein’s John E. McDonald. Bank of America, BAC -4.24 % viewed by many as the most rate sensitive of the big banks, is expected to see a 7.5% increase.

That growth was seen as particularly important as the boost to profits in recent years from cost-cutting and releases from reserves tails off.

Yet those forecasts looked overly optimistic even before this week’s collapse in market expectations for a September rate increase from the Federal Reserve. Now, it is possible banks could even see their interest income contract next year. The sector accordingly took a beating on Thursday, with BofA down more than 4%.

The yield curve has shifted in a way that is particularly unfriendly to banks, with short-term rates rising and long-term rates falling. As of Thursday, any Treasury with a maturity longer than five years had a lower yield than it did 12 months ago. That squeezes net interest margins by making short-term funding more expensive relative to the rates banks can charge for longer-term loans.

Since a large part of net interest income flows through to bank bottom lines, this could have a big impact on next year’s earnings—and today’s share prices. For many of the big banks, shares may have to fall by more than 5% if their forward earnings multiples stay constant. So even after Thursday’s tumble, further declines loom.