Expect stellar earnings from banks in Q1; Capital return could be disappointing

The earnings season is around the corner, and everything seems to be going well for the banking sector. Tepid volatility in trading has been worrying all major banks over the past few quarters. But that seems to have come to a halt now — thanks to the trade war tensions between the US and China, the data-privacy crisis spearheaded by Facebook (FB), concerns involving self-driving technology as well as rising inflation.

However, since much of the stimuli took shape towards the end of the quarter, their impact could be limited.

Meanwhile, the Federal Reserve’s decision to raise interest rates by 0.25% on March 21 would have a positive impact on the banks’ margin, and in turn, their profits. For decades, their earnings have been pulled down by super-low interest rates. Now that the Fed hopes to see sharper climbs in interest rates in the coming two years, in an attempt to keep inflation under check, banking stocks may hope to see some long-term growth.

A record-low unemployment rate will also give consumers more confidence to borrow money for personal expenses, increasing lending for banks.

Adding to these tailwinds is the 14% reduction in corporate tax to 21%. As we had mentioned earlier, banks are expected to be the biggest beneficiary of the tax overhaul as they occupied the largest tax-slab. Major banks including Bank of America (BAC), Wells Fargo (WFC) and JPMorgan Chase (JPM) are expected to witness about 20% spike in earnings driven by the tax impact alone. The tax cut has also spurred M&A activity in the Wall Street, which will provide a fillip to the investment banking units.

Now that the Fed hopes to see sharper climbs in interest rates in the coming two years, in an attempt to keep inflation under check, banking stocks may hope to see some long-term growth.

The finance sector, as a whole, anticipates a combined earnings growth of approximately 19% in the first quarter, driven by trust banks that would benefit from the higher interest rate margins.

Capital return in the time of stress tests

Meanwhile, investors and analysts are doubtful over how the banks would be allowed to increase their share buybacks and dividends in the new tax regime. Adding to this is the Fed’s habit since 2013, of intensifying its stress tests to ensure banks can withstand sharp downfalls. The fact that banks can no longer carry back losses for tax benefits could act as a spoiler in an otherwise stellar quarter.

A few banking stocks that we expect to outperform during the quarter include Southside Bancshares (SBSI), Triumph Bancorp (TBK), Commerce Bancshares (CBSH), Bank of America and JPMorgan Chase.