The banking sector was one of the strongest parts of the stock market in 2017, and it's not hard to understand why. Rising interest rates are boosting margins, deposits and assets are growing, and many banks are getting more efficient. Bank earnings are up nearly across the board. However, 2018 could be another good year for the industry, and our contributors think Goldman Sachs (NYSE:GS), Zions Bancorp (NASDAQ:ZION), and JPMorgan Chase (NYSE:JPM) in particular could have lots of room to grow.
Matt Frankel (Goldman Sachs): For January, I'm keeping a close eye on investment bank Goldman Sachs, which severely lagged the financial sector in 2017. In fact, while the sector rose by more than 19% over the past year, Goldman is up by less than 5%.
While much of Goldman's business has been strong, its bread-and-butter trading revenue has been a weak spot. (Note: If you aren't familiar with how investment banks make money, we recently did an Industry Focus episode about it.) Over the past year, fixed-income trading revenue fell 26%, which is not only bad, but was worse than the decline experienced by many peers. Simply put, market volatility is low, and low volatility typically means low trading volumes.
Despite the poor trading revenue, Goldman's investment banking revenue has grown tremendously, and the bank has the leading market share in common stock offerings and announced M&A. Additionally, the bank's wealth management business is flourishing, and the Marcus consumer lending and banking division has grown impressively.
At just a 23% premium to tangible book value, Goldman Sachs is among the least expensive of the big banks, and management has been taking advantage by repurchasing lots of stock. In the third quarter alone, the bank spent more than $2 billion on repurchases, which should be welcome news to long-term investors.
The bottom line is that if trading revenue turn around, Goldman Sachs could see its profits soar, and it could be a smart time to get in while the stock is still cheap.
This is the bank for rising rates
Jordan Wathen (Zions Bancorp): This West Coast banking franchise stands to gain from rising interest rates and can benefit from expanding margin, as it shifts its balance sheet toward higher-yielding loans.
Zions Bancorp has a treasure trove of non-interest-bearing deposits that are starting to show their value as interest rates rise. Roughly 46% of its total deposits were non-interest-bearing at the end of the last quarter, one of the highest proportions of such deposits of any publicly traded bank. As interest rate rise, Zion's profitability should follow because of the simple fact that it doesn't pay interest on nearly half of its deposit liabilities.
Beyond rate increases, Zions should see its earnings expand, as it redirects cash and securities (bonds) in its portfolio toward higher-yielding loans. More than a quarter of its interest-earning assets are tied up in securities that yield an average of 2.21% per year. In contrast, the company's loans yield nearly twice as much, or 4.27% per year, on average. A shift in its balance sheet composition adds another lever for earnings growth.
Best of all, Zions trades for roughly 1.6 times tangible book value, while peers trade at 2 times tangible book value or more. It's my view that the valuation differential should compress, as rising net interest margin allows its true earnings power to show up in its bottom line, driving Zions stock higher throughout 2018.
Chase this bank stock
Dan Caplinger (JPMorgan Chase): JPMorgan Chase has just come off an impressive year, posting a total return of 27% during 2017, and the Wall Street banking giant looks poised to keep prospering from favorable trends in the industry. A friendly White House has looked to reduce the amount of regulation of banking activity, and moves like the change in leadership at the Consumer Financial Protection Bureau and the potential defanging of Dodd-Frank regulations bode well for future reductions in compliance costs that JPMorgan and its peers will have to pay.
Tax reform also has the potential to help JPMorgan to an even greater extent than some of its peers. Currently, JPMorgan ranks No. 2 on the list of 10 most profitable companies in the S&P 500, and although its international scope gives it a diverse exposure to tax systems across the globe, many believe that the bank could stand to benefit handsomely from the reduction in the corporate tax rate that took effect at the beginning of 2018. With major corporate clients also likely benefiting from tax reform, JPMorgan finds itself on the ground floor of what could be a new period of prosperity for the financial industry. That's already sent the stock to new all-time highs, but it looks like there's more room for further gains if conditions remain as good as they are right now.