Big Banks Aim to Show Higher Profit Ahead as Rates Increase
(Bloomberg) -- As concerns from bank investors go, “peak profitability” seems an unusual one.
But as the biggest U.S. banks report results that analysts estimate will set a new high for profitability this decade, shareholders are wondering: Is this as good as gets, or is Jamie Dimon right that banks are entering a golden age.
“The quarter will be fine,” Susan Katzke, a bank analyst at Credit Suisse Group AG, said in a note to clients. “It’s more about the forward look.”
JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. kick off earnings season for U.S. banks on Friday. Lenders are benefiting from interest rate hikes and a healthy economy, while they’ve tamped down expectations for loan growth and their trading businesses.
Banks will try to reverse the recent trend of underperforming the broader stock market and assuage fears that they’re near “peak profitability” in the late stages of the economic cycle, Bernstein’s John McDonald said in a note last week. Here are some things to watch:
While the U.S. economy has taken off, banks’ loan growth hasn’t kept pace. Analysts are anticipating modest loan growth once again in the third quarter -- Keefe Bruyette & Woods Inc.’s Brian Kleinhanzl expects loans will be up 2.4 percent from a year ago.
Rising interest rates are helping lending margins, but they’re also sapping demand for borrowing in areas such as mortgages. Traditional banks are facing increased competition from nonbanks such as insurers and private equity, and the boom in corporate lending after U.S. tax reform is taking longer to appear than some expected.
“It’s taking a while for tax cuts to work their way through the system,” Barclays Plc analyst Jason Goldberg said in an interview.
While Wall Street trading desks got off to a fast start in 2018, they couldn’t avoid the typical summer slowdown. Analysts expect trading revenue to be roughly flat from last year’s third quarter and down from the second quarter as market volatility subsided.
Earlier this month, JPMorgan Chief Financial Officer Marianne Lake said the bank’s trading revenue will probably drop by about mid-single digits from a year earlier, while Citigroup CFO John Gerspach said his firm may see a slight increase. Equities trading units will probably have a better relative performance than their fixed-income counterparts, according to Credit Suisse’s Katzke.
For all the concerns, the industry hasn’t seen these heights in a long time. The biggest lenders’ third-quarter profits are likely to take their returns on tangible equity to 14 percent over the past 12 months, the best since the financial crisis, Goldman Sachs analyst Richard Ramsden wrote in a note this month.
Banks’ profitability metrics are benefiting from lower tax rates, declining legal bills and record shareholder payouts after this year’s round of Federal Reserve stress tests. The firms have also kept a tight lid on costs even as they spend more on technology. Dimon, JPMorgan’s chief executive officer, said in June that the banking industry is entering a “golden age” on better returns and looser regulations.
Bank stocks haven’t reflected that. The KBW Bank Index is little changed in 2018, while the S&P 500 Index has climbed 7.9 percent. The banking index, up 1.5 percent this month, also trailed the broader market last year.
Deals are happening -- they’re just not closing yet. That’s the message from bankers who saw a 72 percent drop in completed mergers and acquisitions in the third quarter, according to data compiled by Bloomberg. The decline is expected to drive a decrease in investment-banking revenues from a year earlier.
The good news is the value of M&A deals that were announced in the period jumped 3.8 percent, promising a strong finish to the year.
“Announced M&A is still robust and the markets are obviously doing well, so we doubt this marks the end of the cycle,” Oppenheimer & Co. analyst Chris Kotowski wrote in a note.
When new Goldman Sachs CEO David Solomon thinks about the things that can go wrong for his firm, cyber attacks are high on the list.
It’s “a big issue that probably doesn’t get as much attention as it deserves,” he said at the Bloomberg Global Business Forum last month. Investors will be listening for executive commentary on what they’re seeing and how they’re dealing with the evolving threat.
Banks are loathe to give many details on all the ways they protect themselves, but the issue will likely remain a topic among investors as they try to gauge the risks.
“Cybersecurity has to be at the top of every corporation’s list,” Cathy Bessant, chief operations and technology officer at Bank of America Corp., said in a Bloomberg Television interview last week. “It’s a ubiquitous risk and it’s potentially systemic, so it’s real.”
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