Large regional banks continue to outperform the money center banks, despite the compelling stock price multiples for the largest bank holding companies.
Deutsche Bank analyst Matt O’Connor noted on Thursday that while the KBW Bank Index “is down 13 percent from the March 26 high, this reflects a nearly 30 percent pullback on average in the money centers,” including Bank of America, Citigroup, and JPMorgan Chase, while “using the S&P Commercial Bank Index (excludes money centers), the stocks are down a modest 3 percent — despite sharply lower interest rates, slowing economic growth and a much larger potential hit to capital from new proposed rules.”
Summing up second-quarter results for the 17 large banks covered by his firm, O’Connor said that net interest margins (NIM) “were down just slightly on average and remain okay for now, but are not sustainable if rates remain at current levels.”
The net interest margin is a bank’s average spread between its average yield on loans and investments and its average cost for deposits and borrowings. Over the past two years, banks have enjoyed lower funding costs as checking account balances grow, and higher-cost deposits reprice. But with short-term rates unable to head any lower, while long-term rates continue to decline and the Federal Reserve considers additional moves that could push long-term rates even further down, many banks are focusing on cutting expenses. Bank of America
Bank of America, for example is pushing for $5 billion in annual cost savings through the end of 2014, through Phase 1 of its “Project New BAC” program, which focuses on the company’s consumer business.
During the company’s second-quarter conference call, CFO Bruce Thompson said that “we made progress on expenses, which declined $2.1 billion from the first quarter, of which approximately $900 million was due to the absence of annual retirement eligible stock-based compensation awards that impacted the first quarter.”
Thompson said Bank of America was still on track to exceed the 20 percent of the $5 billion in annual cost savings by the end of 2012 from Phase 1 of the expense reduction program. The CFO said that he expected Phase 2 of Project New BAC — focusing on wholesale and investment banking — would lead to expense reductions of “approximately $3 billion on an annualized basis, which would be fully phased-in by mid 2015,” for total target annual expense reductions of $8 billion by the end of 2015.
O’Connor said that eight other large U.S. banks covered by Deutsche Bank “remain focused on reducing costs where possible, even if they don’t have an official cost cutting initiative in place.”
Another major theme for many of the large banks was continued strength in mortgage revenue, as the refinancing wave from the expanded Home Mortgage Refinance Program, or HARP 2.0, continues.
O’Connor said that “production volumes were mostly higher (driven by good refinance activity) and gain-on-sale margins remained strong,” during the second quarter, and that he expects the low rates and HARP 2.0 “to continue to help mortgage activity in (the second half of 2012) ... however, gain on sale margins should eventually come down over time."
Here are O’Connor’s two favorite picks among stocks of large U.S. banks, followed by his two buy-rated money center banks:
Fifth Third Bancorp
Shares of Fifth Third Bancorp of Cincinnati closed at $13.75 Wednesday, returning 9 percent year-to-date, following an 11 percent decline during 2011.
The shares trade for 1.2 times their reported June 30 tangible book value of $11.89, and for nine times the consensus 2013 earnings estimate of $1.52 a share, among analysts polled by Thomson Reuters. The consensus 2012 earnings per share (EPS) estimate is $1.58.
Based on a quarterly payout of eight cents, the shares have a dividend yield of 2.33 percent.
Fifth Third last Thursday reported second-quarter earnings available to common shareholders of $376 million, or 40 cents a share, declining from $421 million, or 46 cents a share, during the first quarter, when the company saw after-tax benefits of roughly $82 million, or nine cents a share, from spinoff of its Vantiv payment processing subsidiary. Second-quarter earnings increased slightly from $328 million, or 35 cents a share, in the second quarter of 2011.
During the second quarter, Fifth Third realized after-tax gains of $36 million, or four cents a share, on the sale of Vantiv shares.
Fifth Third's second-quarter return-on-average assets (ROA) was 1.32 percent, declining from 1.49 percent in the first quarter, but increasing from 1.22 percent in the second quarter of 2011. The second-quarter return on average common equity (ROE) was 11.4 percent, declining from 13.1 percent the previous quarter, and increasing from 11.0 percent a year earlier.
Back in March, the Federal Reserve only partially approved Fifth Third’s annual capital plan, approving the continuance of the company’s eight-cent quarterly dividend and the repurchase of trust preferred plans, but rejecting a planned dividend hike, while only approving common share buybacks in amounts equal to after-tax gains from the Vantiv sale. Fifth Third submitted a revised capital plan to the Federal Reserve in June, saying its plans to return capital to investors were “substantially similar” to the earlier plan. The company expects to hear back from the Fed in August.
Fifth Third is O’Connor's “top pick” among super regional banks, who attributes the stock’s underperformance this year to “disappointment/uncertainty” over the company’s plans to return capital to investors, although “there should be a resolution/more clarity coming soon.”
While Fifth Third didn’t report an increase in mortgage putback claims against the company — which for Bank of America rose a whopping 41 percent during the second quarter — the company said that Fannie Mae and Freddie Mac may begin requesting loan files for nonperforming loans by the end of the year, “likely leading to an increase in repurchase claims,” according to O’Connor.
O’Connor's price target for Fifth Third is $17, and he estimates that Fifth Third will earn $1.56 a share for all of 2012, followed by EPS of $1.65 in 2013.
The analyst said that Fifth Third is attractive now on valuation, with the shares trading “at just 8.7-times and 8.3-times our 2012E and 2013E, respectively vs. 10.2-times and 9.3-times for peers,” implying that concerns over capital return “should be in the stock.” O’Connor added that, “Near term, FITB should continue be one of the biggest beneficiaries of stronger mortgage,” and once the company hears back from the Fed on its revised capital plan, “there could be a positive capital deployment story later this year.”
Shares of TCF Financial of Wayzata, Minn., closed at $9.97 Wednesday, declining 2.5 percent year-to-date, following a 29 percent decline during 2011.
The shares trade for 1.2 times tangible book value, according to Thomson Reuters Bank Insight, and for less than 10 times the consensus 2013 EPS estimate of $1.03. The consensus 2012 earnings estimate is a net loss of $1.18 a share. During the first quarter, TCF reported a net loss of $282.9 million, or $1.78 a share, as the company repositioned its balance sheet by reducing its long-term borrowings.
Based on a five-cent quarterly payout, the shares have a dividend yield of 2.01 percent.
For the second quarter, TCF reported net income available to common shareholders of $31.5 million, or 20 cents a share, increasing from $30.4 million, or 19 cents a share, during the second quarter of 2011.
Second-quarter net interest income increased 9 percent year-over-year, to $144.1 million, which together with $13.1 million in gains on securities, more than offset a 14 percemt year-over-year decline in fees and other revenue to, to $99.8 million. The decline in fee revenue mainly reflected the implementation of the Durbin Amendment’s caps on debit card interchange fees during the fourth quarter of 2011.
With a full quarter’s benefit of the balance sheet restructuring, TCF’s net interest margin expanded to a very impressive 4.86 percent, from 4.14 percent the previous quarter, and 4.02 percent a year earlier.
O’Connor’s price target for TCF is $13, and the analyst estimates the company will earn post a full-year net loss of $1.22 for 2012, followed by earnings of $1.15 a share in 2013.
The analyst said on Thursday that “TCB shares declined meaningful after reporting (second quarter) results — likely due to concerns over credit ... however, credit quality continues to be lumpy at TCF (charge-offs were down sharply in the first quarter, for example) and other trends should be viewed as a relief,” since “service charges rebounded off very low levels, NIM was above mgmt guidance.”
O’Connor expects TCF’s reintroduction of free checking accounts to initially reduce fee income by about $6 million per quarter, but said that “over time, the change in account offerings should drive higher deposits (help NIMs and higher service fees).”
Shares of JPMorgan Chase closed at $35.17 Wednesday, returning 7 percent year-to-date, following a 20 percent decline during 2011.
The shares trade for 1.1 times tangible book value, according to Thomson Reuters Bank Insight, and for seven times the consensus 2013 earnings estimate of $5.21 a share. The consensus 2012 EPS estimate is $4.64. Based on a 30-cent quarterly payout, JPMorgan’s shares have an attractive dividend yield of 3.41 percent
JPMorgan reported second-quarter earnings of $1.9 billion, or $1.21 a share, increasing from $1.7 billion, for $1.19 a share, in the first quarter, but declining from $21 billion, or $1.27 a share, during the second quarter of 2011.
The company’s second-quarter results included $4.4 billion in hedge trading losses , following CEO James Dimon’s initial estimate of "slightly more than $2 billion" in trading losses, back in May.
Investors reacted positively, with the impression that JPMorgan had put most of its “London Whale” trading debacle behind it. There were several other highlights in the company’s second-quarter earnings announcement:
? Period-end commercial banking loans grew to $120.5 billion as of June 30, from $115.8 billion the previous quarter, and $102.7 billion a year earlier.
? Mortgage revenue increased to $2.3 billion during the second quarter, from $2.0 billion during the first quarter, and $1.1 billion in the second quarter of 2011.
? Total noninterest expense declined to $15 billion in the second quarter, from $18.3 billion the previous quarter, and $16.8 billion a year earlier, mainly reflecting a decline in litigation expenses, but also a reduction in compensation expenses to $7.4 billion, from $8.6 billion in the first quarter (the annual seasonal spike for bonuses), and $7.6 billion in the second quarter of 2011.
O’Connor’s price target for JPMorgan Chase is $43, and the analyst estimates the company will earn $4.78 a share this year, followed by EPS of five dollars in 2013, excluding debit valuation adjustments (DVA) and credit valuation adjustments (CVA).
The analyst said that Dimon’s hints that JPMorgan Chase could resume its stock buybacks later this year “seems a bit optimistic in our view,” while the company’s view that it could achieve a Basel III Tier 1 common equity ratio of 9.5 percent by the end of 2012, even with $15 billion in buybacks, “seems aggressive.”
Shares of Citigroup closed at $25.79 Wednesday, down 4 percent year-to-date, following a 44 percent decline during 2011.
The shares trade for just under half their reported June 30 tangible book value of $51.81, and for less than six times the consensus 2013 EPS estimate of $4.54. The consensus 2012 EPS estimate is $4.09.
Citigroup reported second-quarter earnings of $2.9 billion, or 95 cents a share, matching its first-quarter results, but declining from $3.3 billion, or $1.09 a share, a year earlier.
For investors with a long-term horizon, analysts see a huge potential for capital returns from Citigroup, as capital tied up in the company's Citi Holdings subsidiary — which holds assets that are running off, as part of CEO Vikram Pandit’s “good bank/bad bank” strategy to rightsize the balance sheet — is slowly released. The company also has another $63 billion in deferred tax assets that could eventually be utilized, according to Atlantic equities analyst Richard Staite.
O’Connor’s price target for Citigroup’s shares is $40, and the analyst estimates the company will earn $4.05 a share this year, followed by 2013 EPS of $4.64, excluding DVA/CVA.
The analyst said that “(the second quarter of 2012) was a step in the right direction for Citigroup being able to deliver respectable earnings in a tough macro and capital markets environment.” O’Connor added that “one issue for the stock, in our view, has been the volatile EPS power (good earnings in good macro quarters and very weak in bad macro quarters) and a few more quarters like the second quarter should help the stock close its valuation discount to peers.’
—By TheStreet.com’s Philip van Doorn
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