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Analyst Blog

Banks have been hot and one of the best market performers of the year.  Big bank names JP Morgan (JPM - Analyst Report), Zacks Rank # 2, Bank America (BAC - Analyst Report), Zacks Rank #3 , Citigroup (C - Analyst Report), Zacks Rank #2, and Wells Fargo (WFC - Analyst Report), Zacks Rank # 2 , all posted positive Q2 earnings surprises.   The solid results have benefited the overall stock market, but who may be the winner in Q3?

Multiple expansion is a driver:

The bank sector is going through a multiple expansion phase as investors search for value and look for market exposure.  The trade appears more comfortable owning the banking sector given stability in the housing market, improved profitability, and the increased possibility of the Fed tapering its asset purchase program.   The graphic highlights the lift in the price to tangible book value ratio.

Even with the recent rise, Bank America and Citigroup are trading near tangible book value, while JP Morgan is trading slightly under 1.5x tangible book value.  Wells Fargo is the most expensive closing in on 2.0x tangible book value. The graphic suggest there is further room for the price to tangible book value to normalize and rise.

The relatively high valuations at JP Morgan and Wells Fargo may be a function of their dividend yields. At writing, Wells Fargo had a dividend yield of 2.70% which is well above the yields on Bank America (0.28%) and Citigroup (.08%), but about in line with JP Morgan’s dividend yield.

Wells Fargo is seen in strong position to return capital. It hinted in its Q2 earnings report that it was in ready to raise its buyback in 2013.  Investors are slowly forgetting JP Morgan’s “Whale” trading loss, but JP Morgan will be working to meet FDIC capital requirements which could slow the return of capital.

The price to tangible book remains well below the levels seen in the 1999 to 2007 period for all the names.  Still weak real estate lending activity, slow global economic growth, strong corporate cash balances, and regulation are a headwind to profit growth and further multiple expansion.  There are still politicians in Washington who desire to break up large banks.   The chart suggest that a 2.5 price to tangible book multiple is far from historically outrageous for any of the banks.

 Net interest margins stagnate and loss provision tumbles:

The banks all reported lower loss provision as credit conditions have healed from the financial crisis, while net interest margins have moved sideways to lower in recent quarters.  The graphic shows the sum of net interest margin and provision for the four banks, while the  table displays the trend in provision for loss and net interest margin for each company.

Notice that loss provision is back to pre-crisis levels, but net interest margins are elevated and softening hurt by the flat nature of the yield curve between the overnight rate and five years.  It is easy to understand why investors are quick to own bank shares on signs of higher interest rates. Weak growth in net interest margin has been a drag on share prices.

One data point which jumps out is the low loss provision at JP Morgan.  The provision was the smallest since 2004.  Loss provision was also down sharply at Wells Fargo and off meaningfully at Bank America and Citi.   It may be hard for the loss provision to support earnings growth in the coming quarters.

One troubling sign:

Although there has been multiple expansion, tangible book values have not displayed strong growth in recent quarters.  The table highlights the trend in tangible book value per share over the last year.   The sequential increase was limited and the year over year growth rate soft for Bank America and Citigroup in Q2 2013.  

Analyst Agreement strongest for JP Morgan and Wells Fargo:

Analyst estimates have increased most dramatically for JP Morgan and Wells Fargo. The number of 2013 estimate increases trounces the number of estimate decreases over the past 30 days.  However, the increase to decrease ratio has also increased in recent days for Citigroup.   Based on the Zacks agreement methodology, JP Morgan, Wells Fargo, and Citigroup are more attractive than Bank America. This helps to explain the Zacks Rank #3 for Bank America and the Zacks Rank #2 for the other banks.  The table also hints that analysts are becoming more confident in Citigroup's 2014 outlook. The 2014 up to down ratio is higher for Citigroup than JP Morgan.

Conclusions:

JP Morgan and Wells Fargo look like the relative winners based on their Zacks Rank #2 and growth in tangible book value over the last year.  Not surprising, both companies are trading at higher valuations than Bank America and Citigroup.   The upward earnings revisions to Wells Fargo and JP Morgan may keep money flowing into these names and support further expansion in the price to tangible book value ratio.  Citigroup seems more like an up and comer. It recently saw its Zacks Rank jump from #3 (Hold)  to #2 (Buy) and earnings revisions are working higher suggesting the Street is becoming more confident in its turn around.  Investors may look at Wells Fargo and JP Morgan in order to bank further profits, but risk takers may transfer their sights toward Citigroup given its inexpensive looking valuation and upward trend in earnings estimates.

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