Hopes run high ahead of J.P. Morgan, Bank of America and Wells Fargo reports Friday
By Peter Rudegeair
Big banks have weathered years of low interest rates, billion-dollar fines and many regulatory constraints on their businesses. Their latest challenge: living up to lofty investor expectations.
Prospects of President-elect Donald Trump bringing a more benign approach to Wall Street have sent the KBW Bank Index up nearly 24% since Election Day, a gain that is nearly 3 1/2 times the rise in the S&P 500 index over the same period. And analysts have raised fourth-quarter earnings estimates for the big banks on account of better trading conditions and higher anticipated income from loans and securities because of rising interest rates.
With J.P. Morgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. set to release results on Friday, the question is whether they can live up to the optimism priced into their shares. And there is quite a bit of that, especially when compared with this time last year.
Back then, falling oil prices, fears about a hard landing in China and slowing economic growth around the world had some investors fearing a 2008-style meltdown was looming. While banks proclaimed robust balance sheets, their shares traded at deep discounts. Shares OF Bank of America, for one, traded around just 55% of book value, or its net worth, at one point.
Today, Bank of America stock is within striking distance of book value, a valuation it last garnered in September 2008.
"We're in the opposite of where we are last year," said Marty Mosby, an analyst with brokerage Vining Sparks IBG LP. "What we [now] need is the actual realization of fundamental improvement in the banks to justify further movement higher in the stock price."
Over the past 90 days, analysts polled by Thomson Reuters have increased their average per-share estimates for banks' fourth-quarter earnings. Goldman Sachs Group Inc.'s and Morgan Stanley's profit forecasts have risen by 16% and 12%, respectively. Estimates for Bank of America, Citigroup Inc. and J.P. Morgan have increased between roughly 2% and 5%; at Wells Fargo, which is still grappling with fallout from its sales-tactics scandal, estimates have declined by around 1%.
Forecasts for 2017 full-year earnings have risen as well. For J.P. Morgan, they are up 4.8% over the past three months to $6.50 a share; for Goldman, analysts have raised projections 9% to $18.70 a share.
While longer-term catalysts such as a reconfiguration of corporate-tax rates or possible repeal of the 2010 Dodd-Frank regulatory overhaul will take months or years to play out in Washington, the outlook for the banks' bread-and-butter businesses of trading stocks and bonds and making loans will be of more immediate concern to investors.
So far, there are positive signs. Bond-trading volumes were up sharply in the fourth quarter of 2016, especially for municipal and mortgage bonds, according to data from the Securities Industry and Financial Markets Association. As a result, overall bond-market trading volumes did something they haven't done since 2010: record an annual increase.
Thanks in part to the year-end trading surge, average trading volume for the year was the highest since 2013. Much of that should flow to banks' top lines. At an investor conference in early December, the chiefs of J.P. Morgan and Citigroup predicted overall trading-revenue gains of around 15% and 20%, respectively.
Coming on the heels of stronger trading results in the second and third quarters, the hope for banks is that Wall Street has now turned a corner after years of contracting fixed-income revenue.
Banks should also get a boost from higher interest rates, although the impact will take time to flow through to profits. The Federal Reserve's boost in short-term interest rates in December increased the yields banks earn on credit cards, home-equity lines of credit and other consumer loans.
Although the Fed's move occurred too late in the quarter to be a significant source of profit, banks also stand to benefit from a rise in long-term bond yields. This increase gave banks an opportunity to move customer deposits into securities that offered a higher return than just a few months ago.
The difference, or spread, between 10-year and two-year Treasurys, a rough measure of bank profitability, rebounded to 1.24 percentage points at the end of December after hitting a nine-year low of 0.76 percentage points in July, according to data from FactSet.
Banks will be relying on higher earnings yields to power profits as growth in important parts of their loan portfolios has started showing signs of slowing. Commercial and industrial loans, which expanded by more than 8% in the third and fourth quarters of 2015, grew by only 3.7% in the third quarter of 2016 and only 2.9% in November, according to Federal Reserve data.
So far, the market's reaction to the banks' new operating environment has been more optimistic than analysts'. In a research note this week, Sanford C. Bernstein said current bank-stock prices implied that the industry's earnings per share in 2017 would be about 14% higher than their current estimates when using banks' historical price/earnings ratio as an anchor.
Some analysts already are recommending that clients take profits on their bank holdings. On Tuesday, analysts at Citigroup downgraded Goldman Sachs, arguing that to justify the current level of returns the market is pricing in, the investment bank would need to generate an additional $4 billion of revenue above current estimates.
"The path is relatively uncertain and the bar is relatively high," the analysts wrote.
--John Carney contributed to this article.
Write to Peter Rudegeair at Peter.Rudegeair@wsj.com
(END) Dow Jones Newswires
January 12, 2017 02:48 ET (07:48 GMT)
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