Goldman Sachs Lowers Targets for Bank Earnings
Goldman Sachs has lowered its average earnings-per-share target for U.S. banks as financial institutions struggle to grow profits amid low interest rates and fewer loans.
The investment firm is still keeping “buy” ratings on JP Morgan Chase , Bank of America and Citigroup , saying the banks are benefiting from stronger capital market businesses, according to a recent Goldman report on U.S. banks.
JP Morgan, Bank of America and Citi also have the least expensive price per their 2011 EPS estimate, which puts them in Goldman’s favor.
JP Morgan is trading under 8 times an estimated 2011 EPS of $4.75 (down from the previous target of $5.25), and Bank of America is trading at about 7.5 times an estimated 2011 EPS of $1.75 (down from $2.20). Citi is trading at about 8.5 times an estimated 2011 EPS of 45 cents, which was unchanged from earlier.
Goldman’s ratings for other major banks, including Morgan Stanley and Wells Fargo , remain neutral, although their EPS estimates were also lowered.
Overall, banks are suffering from a low interest-rate environment, which limits how much interest they can charge on loans. Low rates also mean banks have to reinvest in lower-yielding securities when securities in their investment portfolios mature, Goldman said.
The average duration of bank security portfolios is five years, which means about 20 percent of these securities will turn over each year. With rates low, banks face a lot of “re-investment risk” from these maturing loans, the firm said.
Wells Fargo, for instance, has a current yield of 6.3 percent on its securities portfolio, 50 percent more than the large-cap bank average. As these securities mature, the yield the bank will receive is closer to 3 percent, Goldman said.
The upshot: net interest margins at banks will be under pressure, and could fall 15 to 20 basis points. Net interest margins fall when a firm’s interest expenses are more than the returns on its investments.
Bank Capital Ratios Are Higher
On a positive note, Goldman said bank capital ratios are up 100 basis points since last year, to 8.5 percent. Once financial institutions have a better idea of new international rules on capital requirements, a number of companies covered by Goldman could boost their dividends “significantly,” the firm said.
A big reason banks are struggling is weak loan growth. Loans were down 1 percent in the second quarter, and Goldman doesn’t expect much to change next year. The firm is forecasting loan growth in the 0 to 1 percent range, compared with a consensus forecast of 2 to 3 percent growth.
While banks are no longer tightening standards, as the Federal Loan Officer Surveyshowed earlier this week, there is no evidence they are easing either. There are some signs, however, that banks will try to boost demand for loans by lowering prices, Goldman said.
The firm said loan growth should turn slightly positive in the second half of 2011.
No Japanese-Style Downturn Seen
Despite the headwinds faced by banks, Goldman isn’t worried U.S. banks will repeat Japan’s experience, where lending fell for eight years while interest rates hovered near zero.
One reason is U.S. banks have been quicker to recognize losses and raise capital. Another is that the housing bubble, by some metrics, was even bigger in Japan, Goldman said.
But perhaps the biggest difference between the U.S. and Japan is the policy response, Goldman said.
The Bank of Japan took more than a year to cut rates and more than seven years to expand its balance sheet, while the Federal reserve cut interest rates 500 basis points and announced plans to buy assets worth 9 percent of GDP.
“Fiscal stimulus was also much faster in the United States than in Japan,” Goldman said.
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