Banks are likely to be among the primary beneficiaries of President-elect Donald Trump’s agenda of fiscal expansion and financial deregulation. And we think the salutary effects of these policies should more than offset the negative impact of potentially protectionist trade measures on the financial sector.
Fiscal expansion typically brings higher interest rates and a steeper yield curve, representing a potentially meaningful earnings boost for banks. If the recent uptick in bond yields is sustained, asset-sensitive U.S. banks will likely grow their top lines, which will push consensus earnings-per-share (EPS) estimates higher.
Further fiscal stimulus via infrastructure spending and public investment would most likely also boost GDP growth and bank lending volumes.
Also on the Trump agenda, a reduction in the corporate tax rate would materially benefit U.S. banks’ bottom lines as well. The U.S. banking industry derives 85% of its earnings from domestic operations, on which it pays an average tax of 32%, based on company filings. Cutting the corporate tax rate to 20% would provide an extra 15%‒25% of upside potential to U.S. banks’ EPS, by our estimates.
Banks and possible deregulation
During his campaign, President-elect Trump pledged to dismantle the Dodd-Frank Act. Many components of the law, however, enjoy bipartisan support. So while some aspects of the act are likely to be modified – for example, regional banks could be exempt from fully complying with Dodd-Frank – other key elements will likely remain in place.
It is difficult to quantify the impact of deregulation, but any reduction in the compliance burden should represent a meaningful tailwind for U.S. banks. There are also potential knock-on effects for European banks in the form of lower settlements for infractions from the U.S. Department of Justice and possibly less stringent capital requirements than the refinements to Basel III that are currently under discussion (dubbed “Basel IV” by the banking sector).
One component of the Trump agenda that could hurt U.S. banks would be protectionist trade policy. However, the effects would likely be felt primarily by the banks most exposed to emerging markets.
The Trump effect is generally positive for U.S. and European bank equities, primarily due to the impact of steeper yield curves on earnings.
The subordinated part of the capital structure – U.S. preferred shares, additional tier 1 (AT1) securities and CoCo (contingent convertible) bonds – will likely benefit from momentum in the equity market and the bigger earnings cushion. Less upward pressure on capital ratios would be slightly negative for these securities, but the current capital position for both U.S. and European banks in general remains robust, with large capital buffers for bondholders.
Currently, we think AT1 bonds and U.S. preferred shares offer attractive valuations with yields between 5% and 9% (based on BofA Merrill Lynch and Barclays indices) and represent a compelling, lower-volatility alternative to bank stocks.
Philippe Bodereau is a portfolio manager in London and PIMCO’s global head of financial research.