What Banks Stocks Are Really Worth
Taking a look under the financial hood can help you better understand which bank stocks are really the “cheapest.”
The easiest way to look at a bank’s real value is by stripping out reserve releases because — at this point in the economic cycle — banks are continuing to release loan loss reserves that are providing a boost to their bottom lines.
Each quarter, most banks make a provision for loan loss reserves, which is the amount added to the reserve to cover loan charge-offs. If the provision amounts to less than the bank's net charge-offs (loan losses less recoveries) that quarter, then the bank has “released” reserves. On occasion, a bank may find that it is so over-reserved, that it will report a negative loan loss provision, transferring money from reserves.
As an example of how important reserve releases are at this point in the economic cycle, Regions Financial reported net income available to common shareholders of $284 million, or 20 cents a share, while it released $239 million in loan loss reserves.
While it is important to note that Regions Financial’s second-quarter earnings were reduced by $71 million, or five cents a share, from the accelerated discount accretion related to the company’s redemption in April of $3.5 billion in preferred shares held by the government, for bailout assistance received through the Troubled Assets Relief Program, or TARP, there’s no question that the reserve release was the main earnings driver.
Shares of Regions closed at $7.05 Monday, trading for less than nine times the consensus 2013 earnings estimate of 80 cents a share, among analysts polled by Thomson Reuters.
Stifel Nicolaus analyst Christopher Mutascio said in a report on Monday that “approximately 26 percent to 27 percent” of his firm’s 2013 earnings per share (EPS) estimates for Regions and Bank of America “are driven by unsustainable loan loss reserve releases.”
The analyst also said that “between the two, our 2013 EPS estimate for Bank of America is of higher quality, in our view, given our projected loan loss provision expense estimate of 1.02 percent of average loans remains above the company’s 20-year median range of 0.80 percent to 0.85 percent, while our estimate of 0.32 percent for Regions is actually below its 20-year median range of 0.40 percent to 0.45 percent.”
During the second quarter, Bank of America’s loan loss reserves declined by $1.9 billion, according to Thomson Reuters Bank Insight, fueling earnings of $2.5 billion, or 19 cents a share.
Mutascio has “hold” ratings on both companies. Stifel Nicolaus estimates that Regions will earn 93 cents a share during 2013, with a 24-cent reserve release, for a ratio of price to forward adjusted earnings of 10.3. For Bank of America, Mutascio estimates 2013 EPS of 80 cents, with a reserve release of 22 cents, for a forward adjusted price-to-earnings (P/E) ratio of 12.6, based on Monday’s closing price of $7.28.
The analyst said that although his firm’s adjusted forward P/E for Regions “is in line with the adjusted peer group median/average, it is much higher than the company’s unadjusted P/E multiple of 7.6 times, which is one of the lowest in the group,” adding that “one could argue that not only is our 2013 EPS estimate for Regions more heavily dependent on reserve releases than others, but it is also suggests the company will be under-providing relative to its historical loan loss provisioning measures.”
Mutascio said that Bank of America “remains the most expensive stock in our large cap bank universe on an adjusted P/E multiple basis, trading at 12.5x our reserve release adjusted EPS estimate versus the group median of 10.2 times,” although “we are cognizant that Bank of America is trading at just 0.55 times 2Q12 book value per share of $13.22.”
Among the 12 large-cap banks covered by Stifel Nicolaus, JPMorgan Chase “remains the cheapest ... on an adjusted P/E multiple, trading at just 7.1 times our reserve release adjusted EPS estimate,” Mutascio said.
Stifel Nicolaus estimates that JPMorgan will earn $5.10 a share in 2013, with a 79-cent reserve release, for an adjusted 2013 EPS estimate of $4.31, and an adjusted forward P/E of 8.4, based on Monday’s closing price of $36.14.
JPMorgan released $2.1 billion in loan loss reserves during the second quarter, according to Thomson Reuters Bank Insight, while reporting second-quarter earnings of $5 billion, or $1.21 a share.
Mutascio still rates JPMorgan Chase a “hold,” saying “unfortunately, we believe the discount to the group will continue due to weak capital markets activity, slower capital redeployment, regulatory risks and EU concerns.” Among the 12 large-cap banks covered by Stifel Nicolaus, “Only 1 percent to 2 percent of our 2013 EPS expectations” for U.S. Bancorp and Wells Fargo “are fueled by reserve releases, representing the lowest contribution in our universe and high earnings quality, in our view,” Mutascio said.
Stifel Nicolaus rates U.S. Bancorp a “hold,” and the company's shares are rather pricy, at 2.8 times tangible book value, based on Monday’s closing price of $33.75. Mutascio estimates the Minneapolis lender will earn $3.10 a share during 2013, with a reserve release of only a nickel a share, making or an adjusted forward P/E ratio of 11.1.
Mutascio rates Wells Fargo a “buy,” and estimates the company will earn $3.65 a share during 2013, with a reserve release of eight cents a share, for an adjusted forward P/E ratio of 9.5, based on Monday’s closing price of $33.96.
The analyst said that based on its analysis of pre-provision earnings estimates, “we still like Wells Fargo and PNC Financial... best within our large-cap bank universe,” since their adjusted forward P/E ratios put “them at a discount to the group median of 10.2x. This discount occurs despite the fact we estimate both companies’ 2013 [returns on average assets] (Wells Fargo - 1.48 percent and PNC - 1.20 percent) will exceed the 1 percent estimated average for the remainder of the group."
Stifel Nicolaus rates PNC a “buy,” and estimates that the Pittsburgh lender will earn $6.90 a share during 2013, with a reserve release of 44 cents, for an adjusted forward P/E of 9.3, based on Monday’s closing price of $59.82.
—By TheStreet.com’s Philip van Doorn
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