Why a Second Stimulus Is So Important for Bank Stocks

With the election now mostly in the books, all eyes are turning toward Congress to pass a second stimulus bill that will hopefully bridge the economy to the other side of the coronavirus pandemic -- or at least to a point when there is a vaccine and a more normal level of economic activity can resume.

For banks, there is a lot riding on another stimulus bill because it can help them further push off or maybe even avoid heavy loan losses. It also might be able to help their earnings power in the low-rate environment. Let's take a look.

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Crucial for credit 

In March, the coronavirus hit the economy fast and hard, sending the banking sector into free fall as stock prices plunged. This was mainly due to all the potential loan losses that banks were facing as unemployment skyrocketed and gross domestic product dipped, making it difficult for borrowers to cover their outstanding debt. At the end of the third quarter, the four largest American banks had set aside a whopping $102 billion for potential loan losses.

Source: Banks' Q3 earnings reports.

But when Congress passed a $2.2 trillion stimulus bill earlier this year, it helped delay a big chunk of the losses that banks expected to eventually materialize. So far, many banks have seen charge-offs (debt unlikely to be collected) and non-performing loans stay steady or even decline from a year ago, when the economy was healthy. That's very unusual in a recession. Loan deferrals from earlier this year have significantly come down as well.

The stimulus did a few things that really helped banks. It enhanced unemployment benefits by adding an additional $600 per week, and it gave many working Americans a $1,200 stimulus check. These actions likely played a role in increasing the personal savings rate, which at one point exceeded 30% this year. The stimulus also allocated more than $600 billion for the Paycheck Protection Program (PPP), aiding struggling commercial businesses that have seen a decline in business or had to close for a period of time. All of these things have greatly helped consumers and businesses keep making their debt payments.

However, as time has pressed on, effects of the first stimulus bill have begun to fade. PNC Financial Services Group (PNC -0.12%) CEO Bill Demchak noted in October that he has seen accounts that received enhanced unemployment benefits begin to decline, making him increasingly worried about the consumer borrower. The personal savings rate has also dropped to 14.3%, which is still a good deal higher than it was pre-pandemic. Additionally, many commercial sectors continue to struggle, including hotels and lodging, travel and entertainment, and retail. A second round of stimulus is expected to include some level of enhanced unemployment benefits, another round of stimulus checks, and a more flexible PPP, among other provisions.

What it means for bank stocks

Credit quality is one of the first things investors look at when evaluating bank stocks -- in good and bad economies. So if the credit outlook worsens again, it will likely spook more investors from the sector. Additionally, bankers are already projecting that significant loan losses won't begin to materialize until the back half of 2021, but that forecast does not include a second round of stimulus. A second round of stimulus could push these losses off even further down the line, and maybe to a point where the economy is operating at a more normal level and borrowers are back on better financial footing. Who knows -- it could even change the ultimate outcome of loan losses.

Further pushing off loan losses and making the total number smaller would allow banks to release some of the billions they have set aside in reserves for loan losses and put them back into earnings. That would greatly help banks' profits, which are likely to be challenged in the low-rate environment.