Bank Earnings Look Great, So Why Are Their Stocks Down?

The big four U.S. banks -- JPMorgan Chase (JPM 0.06%), Citigroup (C 1.41%), Bank of America (C 1.41%), and Wells Fargo (WFC -0.03%) -- all reported revenue and earnings that surpassed analyst expectations, yet their stocks went down. In this Industry Focus: Financials clip, host Michael Douglass and Motley Fool contributor Matt Frankel break down two reasons why investors might be disappointed with the results.

A full transcript follows the video.

This video was recorded on April 16, 2018.

Michael Douglass: Let's talk about trading volume. For a little bit of background, last quarter, one of the big stand-out problems for the big banks was that trading volume was weak. And despite the fact volatility has definitely increased, anyone who's invested in the last month has noticed that volatility has increased, trading revenue is still pretty darn weak.

Matt Frankel: To be clear, this was a good problem to have. The reason trading revenue was weak was because the market was just going up and up and up, interest rates had remained pretty low consistently. So, when the stock market is going up and up and up and there's no volatility, there's less of an incentive for people to trade. Same with interest rates. When interest rates are pretty predictable and consistent, there's obviously going to be lower trading volumes. So, it made sense that that was the problem. That was offset by things like increasing wealth management businesses and the such.

But now, since we've had a pretty volatile first quarter, especially in the context of the past few years, in terms of both the equity markets and fixed income markets, analysts were expecting, especially fixed-income trading, which has been the big problem, to shoot up over the quarter and it just didn't do so as much as expected. In JPMorgan's case, fixed income trading revenue was completely flat year-over-year, whereas analysts were expecting about 3% growth. Bank of America's fixed-income trading revenue missed estimates by about $400 million. Citigroup's fixed-income revenue missed by almost $300 million and was actually down 7% year over year. Now, in all of these cases, equity trading revenue helped make up for it. In Citigroup's case, it was up by 38% year over year thanks to the volatility in the market. But, fixed-income trading was kind of a big letdown this quarter. Analysts just thought it would pick up more than it had because of the nominal interest rates.

Douglass: Yeah, absolutely. This is part of the nature of the big banks, there are trade-offs within the trade-offs. We always talk about how, well, trading will be weak when the market is going up. Well, also within trading, you have your fixed-income vs. your equities, and that's going to be different when you have volatility around interest rates and around stocks. So, there's a lot of moving parts, but that's where that stands.

OK, we've buried the lede enough, let's talk about tax reform. Big, positive moves for the banks on tax reform, big reductions in their effective tax rates.

Frankel: Yeah. We knew this was going to be a big deal for the banks. For those who aren't too familiar, the corporate tax rate dropped from 35% to 21%. So, we knew this would be a big impact on the banks, and it is. Bank of America pointed out that they're expecting a 9% ongoing benefit from this. To put that into some dollars context, this will save Bank of America approximately $3 billion a year based on their current earnings rate. So, this is a big deal. JPMorgan, for the quarter, posted a little over 18%, so did Wells Fargo, for their effective tax rate. Usually, these are in the high 20s. So, that's consistent with Bank of America's 9% prediction. It could be that investors are just finally getting some concrete numbers, and it's less than the spread between the 35% former tax rate and the 21% current corporate tax rate, so, they could have just been expecting a little bit more, and that's a reason for some possible disappointment.

Douglass: Yeah. It's interesting, because I look at this, and within the framework that I'm not confident that big banks are a good investment long-term, this was a pretty darn good quarter for three of the four of them. So, if investors aren't happy now, I wonder when they will be.