"The rate outlook has continued to deteriorate, with our estimates conservatively marked to a forward curve implying 5 further Fed Funds cuts through 2021," wrote Goldman Sachs analyst Richard Ramsden in a note out Monday evening. "We reduce our 2020 earnings estimates by ~2% from lower NII [net interest income]." Net interest income is the amount in interest revenue a bank takes in minus the amount in interest it pays to its lenders.
While the U.S. market is largely pricing in two Fed rate cuts for 2019 -- with the probability for both currently at 69% -- Ramsden points out that five rate cuts are not currently worked into banks' EPS estimates, suggesting the group has further downside from here. "Both the sell-side and buy-side have not fully baked in rate cuts, with our 2020 NII estimates ~2.5% below consensus. However, bank valuations appear to have pre-traded consensus earnings cuts, with bank multiples appearing to discount 4 rate cuts." Many large cap banks are trading around 1 times their book values.
Fortunately for bank investors, lower deposit rates that would ensue would partially offset the negative earnings impact from lower interest rates, but the net impact would be clearly negative.
Goldman says Bank of America (BAC) - Get Report and Wells Fargo (WFC) - Get Report , two very lending-centric banks, are likely to see the worst of the margin compression that Ramsden calls for. Those banks have relatively limited ability to drive deposit rates down. Meanwhile, Citigroup (C) - Get Report and Morgan Stanley (MS) - Get Report are best positioned to withstand the headwind. Morgan Stanley only sees roughly 10% of its revenue from interest income, compared to over 50% for the rest of the group.
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