Without strength in consumer demand, banks that rely heavily on retail banking could suffer when the cheap, easy money goes away. Wells Fargo & Co (NYSE:WFC) reported that 50% of its second-quarter revenue came from net interest income, basically a fancy way of saying its income from loans, 40% of which are residential mortgage loans. Of the bank’s non-interest income, 26% came from fees related to mortgages. With this much exposure and reliance on consumers taking out loans, Wells Fargo & Co (NYSE:WFC) could lose some momentum as rates rise without an improvement on the consumer demand side.
The impact will also reach smaller regional players. U.S. Bancorp (NYSE:USB), a high-performing regional bank, reported that non-interest income related to its mortgage business declined almost 20% year over year in the second quarter. The bank reported that 65.5% of total revenue was generated through net interest income. Again, when rates rise, there is a real risk that consumers will not be willing to take out new loans or refinance existing loans. U.S. Bancorp (NYSE:USB) is already seeing some decline, particularly in its mortgage business.
The problem extends beyond just mortgages and consumer lending. When consumer demand struggles, many businesses also struggle. For banks that have seen strong performance in commercial lending, a struggling labor market could trickle down and have a negative impact on the business lending side as well.
People’s United Financial, Inc. (NASDAQ:PBCT) for example, a regional bank centered in the northeast, reported annualized commercial loan growth of over 14% from March 31 to June 30 of this year. That represents nearly $540 million in new commercial loans in just three months. Without an improvement in the labor market, it’s not a sure thing that this type of performance can continue when interest rates rise.
Banks are, for better or worse, highly reliant on the American consumer. The labor market provides the cash flow and financial stability for Americans to engage in bank services, from mortgages to auto loans to small and middle market business loans. For the banks above and others, the job market must improve significantly for business results and stock performance to continue over the next 18 months.
Without an acceleration in the labor market’s recovery, the medium-term outlook is not pretty
Believe it or not, I do consider myself an optimist. The business sector showed unexpected life in second-quarter GDP, with notable growth in residential construction and in capital investment.
One of the beauties of the U.S. economy is how positively self-reinforcing it can be. As more people get jobs, even if it’s only 160,000 per month, more people will have the means to buy a home, to go to the movies, to invest in the stock market. And as that money works its way into the economy, it will form the basis for another round of growth, another new job, and for the cycle to continue.
The article Why a 7.4% Unemployment Rate Is a Bad Sign for Your Investments originally appeared on Fool.com and is written by Jay Jenkins.
Fool contributor Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Wells Fargo.
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