Tax reforms and lighter regulation figure as key themes in US bank earning season © FT montage / Getty / Bloomberg
It has been a good time to be a bank investor: higher interest rates, along with prospects of lower taxes and lighter regulation, have lifted valuations across the sector. Last week Bank of America stock broke through the $30 mark for the first time since the most intense phase of the financial crisis, bringing gains under president Donald Trump to almost 80 per cent.
But how are underlying results shaping up? Can the banks provide solid numbers to support the big rally?
Here are five things to look out for:
How will the banks deal with tax reform?
Analysts will be keen to hear how banks plan to respond to the Trump administration’s overhaul of tax laws, completed late last month.
Some banks have already announced one-off hits to profits, mainly connected to the revaluation of deferred tax assets, while indicating that shareholders will be much better off over the long-term, thanks to the cut in the main rate of corporate tax from 35 per cent to 21 per cent. At Citigroup, for example, investors could face a charge of about $20bn in the fourth quarter but a return on tangible common equity about 200 basis points higher in future.
During earnings calls executives are likely to be grilled on the implications of the shift from a global to a territorial tax system, under which companies are exempt from the home country’s tax on most or all of their overseas profits.
The new rules have had finance departments scrambling over the past few weeks, looking at the implications of running operations in, say, the UK (a tax rate of 21 per cent) versus Ireland (12.5 per cent).
“You need to completely rethink planning and decision making,” said one Wall Street finance chief, in the week before Christmas. “Now the local tax rate really matters.”
How grim was trading?
It was always going to be tough for the banks to match the Trump-boosted fourth quarter of 2016, when investors of all stripes reset portfolios after the president’s shock election win.
In the end, they did not come close. Last week Deutsche Bank said it expected revenues from trading stocks, bonds and derivatives to drop about 22 per cent for the fourth quarter from a year earlier, blaming low volatility and low levels of client activity in key businesses. Last month top executives at Citi and BofA made only slightly less bearish noises, talking about drops in the mid to high teens.
Trading will be “crappy”, said Glenn Schorr, analyst at Evercore ISI. “Worse for brokers than banks, but will anyone care at this point?”
What happened to loan growth?
It has been a real head-scratcher for investors: why demand for loans failed to pick up last year. Record-high stock markets, still-low interest rates, an economy growing at a fair rate — and yet corporate treasurers sat on their hands. The average weekly rate of business-loan growth was 2.7 per cent for 2017, according to Federal Reserve data, compared with 9.3 per cent in 2016 and double-digit growth in the two years before that.
Expect bank executives to be grilled on the reasons why, and the chances of an acceleration in 2018.
How do they feel about prospects for regulatory relief?
Bank executives are unanimous that there has been a real shift in tone from a new crop of Trump appointees at the helm of the top agencies. After years of ever-tougher rules, and ever-tougher interpretation and enforcement of those rules, they say the new faces seem determined to be less strict with the banks.
It is normal for a new administration to change tack, said Oliver Ireland, partner at law firm Morrison & Foerster and a former associate general counsel at the Fed.
“But it’s happening in a more organised and more co-ordinated way in this administration than in the past,” he said.
Despite this changed atmosphere, though, it is too much to expect Congress to start rewriting laws to benefit the big banks, said Bill Smead, chief investment officer and chief executive at Smead Capital Management in Seattle. Elizabeth Warren, the powerful Democratic senator from Massachusetts, remains the banks’ “mortal enemy”, he noted, having “built a political career on dunking on these guys and making their lives as miserable as possible”.
“Our theory is, you won’t cure eight or nine years of the deepest hatred ever, in a year and a half of rally.”
How much ‘kitchen sinking’ will there be?
An unusually noisy quarter is expected, with tax and trading likely to dominate, and with investors apparently determined to focus on the prospects of higher returns to come.
It will be tempting, then, for banks to dispose of more bad news into the period, marking troublesome assets lower and bringing certain expenses forward, to create a more flattering basis of comparison for the year ahead.
Dick Bove, veteran analyst at Vertical Group in Tampa, Florida, notes that Goldman Sachs — which has said it will take a quarterly charge of about $5bn for various tax-related reasons — has $333bn in trading and derivatives assets, $188bn in securities and $149bn in loans.
“There are billions of dollars of subjective valuations that can be reassessed at any time in these companies,” he said. Tax charges are “a golden opportunity to . . . get rid of unwanted problems”.
This post originally appeared on Financial Times