Why Big Banks Are So Fascinated by 1995 (Video)

Does this sound familiar?

The pace of inflation was slowing as American consumers spent. So the Fed cut interest rates by a quarter in July. It did so again in December — and again in January.

That was in 1995—and those rate cuts kicked off one of the best multi-year periods for banks in U.S. history. The broadly tracking sector index would end the year up more than 40%, outperforming the S&P 500 (GSCP). And that outperformance would continue for the next two years.

Could 1995 repeat itself for big banks? As it is now, that could be the scenario for 2025 as the Fed considers rate cuts. But that hasn’t stopped Wall Street from thinking about that great year — and what it will take to see that kind of winning streak again.

So far, the industry has had a good start in realizing this dream.

This year, the same banking sector index (^BKX) is up more than 14%, while an index focused on regional banks is up 8%. True, both have lagged some of the major indices. But an even broader financial sector index, the Financial Select Sector SPDR Fund (XLF), which has about a little less than a quarter of its exposure to the country’s largest banks, is up 19%.

“History is unlikely to repeat itself, but it may rhyme,” Mike Mayo, a Wells Fargo analyst who covers the nation’s largest banks, said of the comparison to 1995. While Mayo doesn’t expect next year to be as good as that mystical year, he sees similarities.

In three instances (1995, 1998 and 2019) when the Federal Reserve cut interest rates and a recession did not occur, bank stocks initially sold off on average after the first cut, then rallied a few weeks later — outperforming the S&P 500, according to an analysis by Wells Fargo Securities.

But a broader review of the past six rate-cut cycles (including three that were followed by recessions) shows that industry outperformance typically doesn’t last long. Only in 1995 did banks outperform the broader stock market for more than three months after the first rate cut.

At that time, it was not only monetary policy that benefited banks.

A tough start

The industry began the year in poor shape. Major institutions collapsed, including the Orange County, Calif., commune, which filed for bankruptcy in December 1994, and the British merchant bank Barings, which collapsed in February 1995. Banks with large trading desks had suffered heavy losses from the previous year’s bond market collapse—and commercial real estate lenders were still reporting losses on loans from the crisis that began in the late 1980s.

Meanwhile, real US GDP fell below 1% in the first half of the year. And the yield on longer-dated 10-year Treasury bonds fell by 250 basis points.

But crucially, these long-term yields have remained higher than short-term bonds. This has allowed banks, which borrow at short-term rates and lend at long-term rates, to profit from a larger margin on the difference.

But interest rates were not the only driver of growth in bank profits in 1995.

U.S. banking regulations were also entering a period of easing, starting with a federal law signed by then-President Bill Clinton a year earlier. That law lifted restrictions that prevented banks from opening branches in other states, setting the stage for a period of deregulation that would eventually lead to the rise of mega-banks in the country, such as Wells Fargo (WFC) and Bank of America (BAC).

Introducing regulations like in 1995 again?

Without delving too deeply, Wells Fargo’s Mayo said, “It looks like the regulatory pendulum may be swinging that way.”

While banking regulations have tightened since the Trump administration, big banks have recently become bolder in confronting regulators over disagreements. The Supreme Court also invalidated the so-called Chevron doctrine, which gave regulators deference in more legally ambiguous litigation.

Regulators last week also unveiled new bank capital rules that mark a rollback of initially more stringent increases.

What’s so different this time around compared to 1995 is that the current policy shift comes on the heels of one of the longest periods of low interest rates in U.S. history. With deposits flooding into banks during the pandemic, that unusually long and easy period left many lenders in a bad position to adjust to the steep rate hikes, said Allen Puwalski, chief investment officer and co-portfolio manager at Cybiont Capital.

“There’s no argument that falling interest rates are good for banks. I’m just not sure it’s for the same reasons as in 1995,” Puwalski added.

For next year to be anywhere near as good as it was for banks 29 years ago, the Fed will first have to achieve a so-called soft landing scenario—that is, lower inflation without triggering an economic recession. And even if it doesn’t look as good for banks as it did in 1995, that’s exactly what happened then.

“There are a lot of things that could go wrong,” former Federal Reserve Bank of Boston President Eric Rosengren told Yahoo Finance. “But I think there’s enough probability that we can still talk about a soft landing.”

Dream or fever dream?

For now, 2025 looks like a mixed bag for bank profits. Lenders that benefited from high interest rates are likely to see their profits fall, while those left behind are expected to see their profits rise.

Even without a U.S. recession, a repeat of the 1995 situation would require an increase in lending and a further resurgence in investment banking.

At a Barclays conference last week, some bank executives, including Bank of America CEO Brian Moynihan and PNC (PNC) CEO Bill Demchak, reiterated their expectations for higher profits in 2025.

Others do not.

JPMorgan Chase (JPM) Chief Operating Officer Daniel Pinto told investors that analysts are “a little too optimistic” about how much the bank will earn in 2025.

“Our credit challenges worsened during the quarter,” Russell Hutchinson, chief financial officer of Ally Financial (ALLY), said the same day, referring to the bank’s retail auto business.

Gerard Cassidy, an analyst at RBC Capital Markets, predicts that banks will see higher revenues next year, but also greater credit problems.

“In our view, we expect to see progressively higher credit loss provisions over the next 12 months,” Cassidy added.

This much is clear: While betting that banks will have another 1995 next year may ultimately prove risky or foolish, the industry is changing again. For now, the arrows seem to point in the right direction.

David Hollerith is a senior reporter at Yahoo Finance, covering banking, cryptocurrency and other areas of finance.

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