Wall Street likes Wall Street as an investment pick.
The Federal Reserve hiked interest rates on Wednesday, putting an end to the zero interest rate policy era. Investors and analysts expect those higher rates to help banks’ bottom lines.
That dynamic, combined with the potential for mergers-and-acquisitions activity and lower legal expenses, has Wall Street bullish on the prospects for the banking sector as a whole.
“One sector that might really surprise is the financial institutions,” Ram Gandikota, senior portfolio manager and associate director of research at fund manager Ativo Capital, told Business Insider.
This reflects sentiments from around Wall Street itself, as a number of analysts from larger financial institutions have pointed to the possibility of outperformance in financials in 2016.
Gandikota, whose firm managed over $1 billion as of October, cited three reasons the banks could outperform.
- A rate hike from the Fed: “As interest rates go up, that’s pretty good news,” said Gandikota. “That should help increase earnings and improve [return on investment].” As interest rates go up, banks should be able to improve their net interest margin, or the difference between their cost of funding and lending rates.
- Finishing up fine payouts: “A lot of banks have had to pay out multi-year fines, and those fines are almost done with,” said Gandikota.
- Consolidation: “Also, you have a smaller number of players within parts of the industry,” said Gandikota. “The consolidation in the industry will help make it easier for those still in the space.” He points out that it isn’t the big mergers and shutdowns anymore, but banks are shuttering individual sections of the business. Gandikota pointed to prop trading and mortgage businesses in particular.
These reasons, for the most part, coincide with the outlooks from analysts from at JP Morgan, Goldman Sachs, Deutsche Bank, and Morgan Stanley.
Morgan Stanley agrees with the basic idea of increased business after a possible Fed rate hike.
“Higher interest rates in the US — particularly an increase in the Fed funds rate — will have a direct and positive impact on the profitability of the US banks,” said the company’s analysts in a note to clients. “The broad reason is because the banks will earn more on their assets than they will pay on their liabilities, which in turn, drives higher net interest income and, thus, higher earnings.”
In the note, they estimate that 37 of the 44 US commercial banks in their coverage will see an increase in net interest income after a Fed hike.
JPMorgan chief global strategist David Kelly also said that interest income would increase. He told Business Insider that there could be an increase of as much as $60 billion in interest coming to banks if the Fed rate were to reach 1%, though that wouldn’t all come to Wall Street.
Wall Street also agrees with Gandikota about consolidation, through mergers and other investments.
“M&A will also be a key tool for growing earnings and potentially an avenue for banks to deploy excess capital they are not currently getting full credit for,” wrote Richard Ramsden and his team at Goldman Sachs in a note to clients on December 4.
Wall Street is even anticipating the fines rolling off. Morgan Stanley analysts said back in August that US banks had already paid $137 billion in fines from the financial crisis, and that they expected a further $14 billion would be paid, meaning US banks had paid out the bulk of their fines.
Not everyone is bullish.
Frederick Cannon and his team at KBW think investors will be disappointed by the limited impact of a Fed rate hike on bank earnings, for example.
“We expect that many financial stock investors will be disappointed due to limited positive earnings impacts from higher rates,” he said in a December 3 note.
But the share price reaction to the Fed hike move seems to suggest Wall Street is broadly bullish on itself heading into 2016.