NEW YORK/LONDON (Reuters Breakingviews) - Owners of Wall Street banks are being taken for a Washington ride. The S&P 500 Bank Index has surged 12 percent since Sept. 8. That is not justified by the trajectory of earnings, as JPMorgan and Citigroup showed on Thursday with results that were no better than steady. Tax cuts would support higher stocks, but they’re at best some way off. In the meantime, banks have other concerns.
JPMorgan and Wells Fargo each trade around 50 percent above their book value. Goldman Sachs and Morgan Stanley are neck-and-neck at some 1.3 times book, while laggards Bank of America and Citi trade at par.
Using the rule of thumb that big banks need to deliver 10 percent returns for their shareholders, JPMorgan’s valuation means it ought soon to be cranking out a 15 percent return on book equity. Yet the bank run by Jamie Dimon will only hit an ROE of 13.6 percent by 2020, according to estimates collated by Thomson Reuters. Across the first three quarters of 2017, it managed only an annualized 11 percent.
If President Donald Trump and Republicans in Congress succeed in cutting corporate tax rates to, say, 25 percent from the current 35 percent headline rate that could, in theory, boost any tax-paying U.S. company’s net profit by 15 percent – turning JPMorgan’s sub-14 percent return into one above 15 percent. It’s a similar story at Citi. An ROE of just over 7 percent so far this year increasing to an estimated 8.7 percent in 2020 could get near 10 percent with lower taxes.
The trouble is, that wouldn’t just require difficult tax legislation. It also needs banks to dodge problems elsewhere. Sluggish loan growth is one. That’s especially true for large banks, where lending has grown just 1 percent this year, compared with 6 percent at smaller banks, according to the Federal Reserve. JPMorgan managed a 3 percent increase in the year to September - though core loans grew faster. Citi’s loan book expanded by 2 percent.
Loan defaults are rising, too. Citi has already warned of higher losses in its U.S. credit-card unit. Even share buybacks, which reduce book equity and share count thereby increasing ROE and earnings per share, offer less bang for the buck: bank stocks are over a third more expensive than on the eve of last November’s U.S. election.
There may be no obvious calamity ahead. But there are enough obstacles to slow U.S. bank bulls down.
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