Investors in Bank of America (BAC -1.07%) have plenty of reasons to be optimistic about the bank's performance in the current quarter, the results of which will be released in the middle of next month. Short-term interest rates are heading higher, the regulatory burden is easing, and Bank of America's turnaround since the financial crisis is gaining momentum.
Yet at least one prominent bank analyst has recently lowered his second-quarter earnings estimate for the Charlotte, North Carolina-based bank. In a research note to clients last week, KBW's Brian Kleinhanzl reduced his earnings-per-share estimate for Bank of America by 8%, dropping it from $0.48 previously down to $0.44.
Kleinhanzl offered a number of reasons for doing so, but the most important is an expected drop in trading revenues at universal banks -- i.e., banks with both commercial and investment-banking operations. "Market volatility has fallen off after first-quarter results were announced and we expect the environment to remain subdued through quarter-end," wrote Kleinhanzl. "As a result, we are updating our trading revenue forecast to reflect lower volatility and lower market activity."
This would contrast sharply with the first quarter of the year, in which banks saw their trading revenues climb. In Bank of America's case, sales and trading revenue in its global-markets division rose 23% through the first three months of the year compared to the same period in 2016. This was led by a 29% boost to fixed-income trading and a 7% improvement in equities trading.
To be fair, Bank of America's trading results in the first quarter reflected an easy year-over-year comparison, given that the same period in the prior year was marked by a meaningful, but short-lived, correction in the market. Events like that lead institutional investors to stay on the sidelines as opposed to paying Bank of America and other market makers on Wall Street to help facilitate the purchase and sale of securities.
Kleinhanzl also pointed out in his research note that the recent decline in long-term interest rates could weigh on Bank of America's earnings, too. This follows from the fact that higher interest rates translate into higher loan and securities' yields, which pads a bank's revenue and profit. It's true that long-term rates are higher than they were at this point last year, but over the past few months, they've begun to retreat, as you can see below in a chart of the yield on 10-year Treasury bonds, the primary long-term interest rate benchmark in the United States.
10 Year Treasury Rate data by YCharts.
Despite these short-term headwinds, Kleinhanzl nevertheless expects large banks like Bank of America to outperform the broader market going forward. He noted that bank stocks continue to trade at a meaningful discount (34%) to large-cap stocks, more generally. Moreover, with the Federal Reserve in the process of raising short-term rates, which is positive for Bank of America, and with the results of the stress test due out at the end of this month, which could free the nation's second-biggest bank by assets to raise its dividend and buy back more stock, there's still plenty of positive catalysts for investors in bank stocks to look forward to.
That said, I nevertheless urge investors to tread carefully right now. These catalysts are presumably already baked into Bank of America's stock price. And with the market making new all-time highs on a regular basis nowadays, it's my opinion that there's more to gain than to lose by waiting for a potential pullback before buying more stocks.
