Get ready: between lower regulation, higher interest rates, and more share buybacks, 2018 could be kind to long-suffering bank investors, analysts say.
“We believe large-cap bank stocks have the ability to continue to increase, as well as outperform the market, over the next 12 months,” wrote Jason Goldberg, a Barclay’s analyst, in his 2018 preview.
Goldberg’s big bank universe includes Bank of America BAC, +0.94% Citigroup C, +0.97% JPMorgan Chase JPM, +1.25% , and Wells Fargo WFC, -0.08% .
Chris Whalen, a bank analyst and financial services consultant, agrees. “Bank earnings in 2018 are likely to continue to rise with asset returns, and expenses are likely to fall as regulatory changes ripple through the world of banks and non-banks alike,” he wrote.
But there are some caveats, not least that expected “reflation” and the animal spirits of lending and spending have continually failed to materialize, year after year.
Net interest margins could expand:
To be profitable, banks need a bigger spread between short-term interest rates — what they pay for deposits — and long-term rates, which they receive for lending.
Interest rates — and the spread between them — have been depressed in the wake of the financial crisis, as is to be expected in a sluggish economy. When the “yield curve” steepened after the surprise presidential election, it was because investors expected faster growth.
Barclay’s Goldberg believes the margins banks get from that spread will grow by eight basis points next year, slower than 2017 but better than 2016. And most analysts think more Federal Reserve rate hikes, plus the fiscal stimulus from the congressional tax plan, will steepen the curve even more, benefiting banks.
But as has been the case for years, the yield curve isn’t behaving, and some analysts, including JPMorgan’s team, think it may get worse before it gets better, and that the Fed’s plans for steady rate rises may again be stymied.
Read: Yield curve flattens after poor economic data, but traders keep eye on tax-bill hiccups
“If as we suspect the yield curve inverts next year, the FOMC may need to rethink its schedule for benchmark rate increases,” Whalen wrote.
As David Hendler, founder of Viola Risk Advisors, puts it, “The way banks deal with it is volume.”
Growth in lending:
Goldberg expects only “modest” loan growth, although Hendler thinks mortgage lending volumes may surprise to the upside.
The banks themselves say tax cuts will juice demand. At an early-December conference, Bank of America CEO Brian Moynihan said the bank has been ramping up hiring of loan officers and expects solid demand.
“You’ve heard some people now say they’ll increase their capital expenditures and that will accelerate,” Moynihan said. “So I think that’s what our corporate clients are telling us. They have been waiting for some certainty here to figure out what to do to plan across three- to five-year periods, which they as entrepreneurs and CEOs have to do. So I think it will unleash some activity, no question.”
Still, it’s worth noting that CEOs themselves have told the Trump administration exactly the opposite.
Less overhead:
If there’s one thing that’s certain, it’s that banks will be regulated less. That means not only a freer hand in how they run their businesses—but also less time, money, and energy devoted to compliance exercises.
In December, the Senate Banking Committee approved a bill that would vastly reduce the regulatory burdens on small and mid sized banks. While it would do little for big banks, it’s just one part of the de-regulatory fever sweeping Washington. (JPMorgan analysts who cover mid- and small-cap banks see what they call a “Goldilocks” scenario ahead for 2018. Their picks for 2018 include First Republic FRC, +0.00% KeyCorp KEY, +0.76% and Comerica CMA, +1.15% .)
Incoming Fed chairman Jerome Powell, among others, has said that he believes banks of all sizes are regulated enough, and could stand some relief.
Hendler wonders whether the emphasis on rolling back regulations currently in place may be a matter of fighting the last war. “Does the Volcker rule matter any more?” he said. “Is that even the business model any more? There’s a view among investors that proprietary trading is a boom-and-bust business and it’s not worth the hassle.”
The best example of that is Goldman Sachs GS, +0.72% at one time the poster child of Wall Street proprietary trading, now re-styling itself as a consumer fintech lender, Hendler noted.
Reasonable valuations:
Bank stocks are relatively cheap. Forward price-earnings multiples for big banks are about 70% of the average for the broader S&P 500, Goldberg noted, “and below its 15-year average despite accelerating EPS growth, active capital management, and several potential positive catalysts.”
Banks are taking the opportunity to buy back shares, and analysts like Hendler see value in even Wells Fargo. “It’s an opportunity to buy a quality franchise at a discount.”
But, some wild cards:
Banks have spent the past few years slashing costs, and may have to spend more than they expect in the near future, JPMorgan analysts noted. Their CFO, Marianne Lake, said as much at a recent conference.
“We’ve seen over the last year that our expenses have been from $56 billion to $58 billion. We expect the absolute dollars to continue to grow.”
Another possible turn of event for banks, Hendler believes, is fintech disruption. No, Amazon AMZN, +0.19% and Google GOOG, +0.59% aren’t going to turn into banks in the next 12 months—but if such a big tech company moved into the space, it could pull significant market share from banks. Just the signal of such a turn of events could make things choppy for banks.
Read: Here’s the next industry at risk of facing the ‘Amazon effect’
Moody’s Investors Service agrees, writing in a recent outlook, “While we do not expect incumbents to lose their position at the center of banking services any time soon, 2018 will bring ongoing challenges to their competitive position.”
What does it all mean for stocks?
Wells Fargo: Analysts surveyed by FactSet have a mean rating of overweight on the beaten-down stock, and a price target of $59, just pennies above its trading range on Thursday morning.
Citi: FactSet analysts are overweight Citi, and have a $77.20 price target—2% higher than its trading level Thursday.
JPMorgan: The FactSet consensus is overweight, with a price target of $101.67, below its Thursday price of $104.93.
Bank of America: Another overweight rating, another target — $28.52—fractionally lower than its price on Thursday.
The S&P 500 SPX, +0.55% has gained 17% in 2017, while the Dow Jones Industrial Average DJIA, +0.49% has gained 22%.