Bank of America’s Shares Saw A Strong Performance In 2017, Even As Banking Sector Underperforms

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The year 2017 was characterized by an upbeat equity market, with the strong economic outlook at the beginning of the year being supported by steady growth in corporate profits. While the Fed’s decision to raise benchmark interest rates at regular intervals reinforced investor confidence, expectations of a more corporate-friendly environment in the U.S. were finally met in December when the Trump administration pushed through the Tax Cuts and Jobs Act.

Notably, the rally in the U.S. stock market saw the S&P 500 post gains in each of the twelve months of 2017 for the first time in more than fifteen years. Interestingly, the fact that the rally was steady with extremely low volatility had a negative impact on the largest U.S. banks. This is because low volatility in the equity and debt markets for most of the year suppressed demand for securities trading services from these banks – hurting their trading revenues. Besides this, a notable increase in card charge-off rates coupled with a slowdown in loan growth mitigated some of the gains realized by the banking sector from improving interest rates. This would explain why the KBW Bank Index underperformed the broader U.S. equity market indexes for full-year 2017. While the S&P 500 ended the year with gains of 18.1% and the Dow jumped 24.1%, the KBW Bank Index gained 14.6%. This compares with gains of 23.8% for the banking index in 2016.

That said, many of the largest U.S. banks saw their share prices reach all-time highs again this year, with many of them holding on to their gains at the end of the year. Bank of America (NYSE:BAC) stood out, with gains in excess of 30% for the year, with the diversified banking giant getting the Fed’s approval late in the year to repurchase an additional $5 billion in sharesU.S. Bancorp (NYSE:USB) was the laggard among the country’s 10 largest banks with gains of less than 3% largely because the bank already trades at more than double its book value – the highest among these banks.

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See our full analysis for Morgan Stanley | JPMorgan | Bank of AmericaU.S. Bancorp | Goldman Sachs

The table below summarizes the change in prices for major bank stocks for each of the last five years.

Overall, 2017 was a better year for most of the banks in terms of share price appreciation than any year since 2013. Investor confidence in the banking sector has improved considerably since 2011, despite several obstacles along the way in terms of tightening regulatory requirements, the high-profile interest rate and forex rigging scandals as well as poor internal risk-control frameworks at the largest global banks. This confidence has improved due to the diligent efforts put in by the banks to clear their legal backlogs, while improving economic conditions have lent a helping hand to their bottom lines. The U.S. banking giants have put all their legacy issues behind them and have refocused their business models around their core strengths – something that portends sustainable growth in the future.

We believe that the current increase in loan charge-off rates across the sector is the result of normalization from the unusually low levels seen over 2012-15, and should not be a cause of concern in the long run. Also, the sub-par loan growth seen over recent quarters is a result of the Fed’s ongoing rate hike process, and should improve once the interest rate environment stabilizes. You can see how better-than-expected growth in Bank of America’s mortgage portfolio impacts our estimate for the bank’s share price by modifying the chart below.

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