3 Big Trends in Bank Earnings

MarketsMotley Fool

In this episode of Industry Focus, host Michael Douglass joins contributor Matt Frankel to talk bank earnings. While no two banks' earnings reports are the same, there certainly are some industrywide trends. Trading revenue is a weak point, interest margins are expanding, and banks are getting more efficient. Here's a rundown of each of these trends, and what they could mean for investors.

A full transcript follows the video.

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This video was recorded on Jan. 22, 2018.

Michael Douglass: With that in mind, let's head on over to trading revenue, which was another one of the big headline things that we saw across the banks, that trading revenue was down substantially. This was something we highlighted last quarter, in large part because of low volatility. Frankly, when the market just keeps going up, it's a lot more difficult to make that kind of money in trading revenue.

Matt Frankel: Right. This is Goldman Sachs' (NYSE: GS) and Morgan Stanley's (NYSE: MS) bread and butter, and the kind of really dropped the ball on this quarter, for lack of a better term. Fixed income especially is a really tough environment when volatility stays low like it has. Goldman's fixed-income trading revenue was down by 50% year over year, so, half of what it was before. Morgan Stanley's was down 46%.

Surprisingly, some of the universal banks didn't do too bad. Bank of America's was only down 13%. Its equity trading revenue didn't drop at all. I think [JPMorgan Chase] was somewhere in the middle in the 20s, as far as their trading revenue drop. But this is definitely something to keep an eye on. If the market happens to drop and volatility picks up, this is kind of a safety net for some of these banks, because Goldman's trading revenue is going to go through the roof if the market starts to plunge or gets pretty volatile. This is definitely an area to keep an eye on.

Douglass: Yes. It's interesting, when things are going well, there are parts of the banks that do well, and when things are going poorly, there are parts of the banks that also do well, and of course, those are balanced out by parts that are doing poorly. In this case, it's definitely a big hit to, particularly, Goldman Sachs.

Let's talk a little bit about margin expansion as well. If you spend time on the internet, and if the marketers out there think that you're interested in certificates of deposits and savings rates and stuff -- I'm one of those people that they very much think are interested in this, and it's because I am -- you've probably seen an uptick in the advertised CD rates and savings account rates that are making their way around the internet. And that's because interest rates have increased. The Fed has bumped them and plans to continue bumping them. Also, if you have a credit card, you probably noticed that the interest rate charges that you could theoretically incur if you don't pay off your balance each month have also increased, and that's, again, because of interest rates increasing.

Keep in mind, when interest rates increase, banks usually increase their payouts, how much they're going to pay out to try and attract your deposits, particularly in a CD or a savings account or a money market account. On the flip side, they're also going to charge more for loans. And their margins expand when they're able to charge more, when they're able to grow the amount that they're charging for loans by more than the amount that they're paying out extra for CDs and savings accounts. That's very much what's happening across the board.

Frankel: Yeah. We've seen this in most of the big banks. It's not a completely predictable relationship, but generally speaking, the banks are seeing about 10 basis points of margin expansion as opposed to this time last year. But when you're talking about banks with $1 trillion in loans --

Douglass: [laughs] That's a lot of money.

Frankel: That's a lot of money. So this is definitely a positive catalyst. And looking forward, the Fed is expected to raise rates at least three times this year. Now we're hearing chatter of maybe four, and another couple times in 2019, maybe a couple of more times in 2020. We're still in the early stages of the rate-hike cycle. So this could definitely be a trend that we're seeing over the next few years, that margins will continue to expand.

Douglass: Yes. Investors in banks with significant loan operations who have been craving seeing some kind of growth for a long time, probably going to see some significant rewards over these next couple of years, at least in terms of, at least a moral victory, like, "I knew this was going to happen eventually."

Now, of course, whether stock prices fall, that's an open question. How much of that is already baked into these stock prices is perhaps another conversation for another day. But definitely, the underlying metrics are starting to look increasingly good. And one other thing that I'll highlight -- lower efficiency rates. Bank of America and Citigroup, I noticed, particularly, had their efficiency rates down for 2017. Citigroup is down to 58%, which is pretty unheard of, given that it's historically been a comparatively inefficient bank. For background, remember that an efficiency ratio, 60% or below is considered very good. So, really, really good news to see for those two.

Frankel: Yeah, definitely. What I would like to add with efficiency ratios is, take the fourth-quarter efficiency ratios with a big grain of salt, just because of these tax charges. For example, U.S. Bank had a 70% efficiency ratio. We all know, anyone who follows that company knows, U.S. Bank does not operate at a 70% efficiency rate.

Douglass: [laughs] Right. That's why I highlighted year-long, for exactly that reason, because most of them crept up in the fourth quarter.

Frankel: In general, take fourth-quarter metrics you're reading in U.S. Bank earnings with a grain of salt.

Douglass: [laughs] Right, I think that's very fair.

Matthew Frankel owns shares of Bank of America. Michael Douglass has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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