Big Banks? Go to Europe - Analyst Blog
Banks start releasing earnings tomorrow with Wells Fargo ( WFC ) and JP Morgan ( JPM ) kicking off the season. Bank lending was mixed in Q3. As the graphic following displays, lending to consumers has been slowly building and rising consistent with the trend in recent years. Real estate lending has fallen off after showing light signs of stability. It looks like higher mortgage rates hurt demand. Commercial and industrial loan growth rose early in Q3, but has flattened in recent weeks. Lending data is not overly exciting for the sector and does not bode well for strong profit growth.
The earnings trend:
The earnings outlook for the four largest U.S. banks has been neutral to negative with earnings estimates under pressure. The trend in estimates seems consistent with the trend in lending as seen in the chart above.
JPM has seen its Q3 Zacks Consensus Earnings per Share Estimate cut by 11 cents $1.29 and its Q4 EPS projection reduced 8 cents to $1.32 over the past thirty days. There has been less movement at WFC. Q3 EPS projections are flat for WFC over the past 30 days and expected Q4 EPS are down 1 cent to $0.97.
Over the past thirty days, Citigroup ( C ) has seen its Q3 Zacks Consensus Earnings per Share Estimate decline 9 cents to $1.07 and its Q4 projection cut 1 cent to $1.16. BankAmerica ( BAC ) has seen its Q3 EPS estimate reduced 1 cent to $0.18 and no change to its Q4 forecast which is $0.29.
JPM, WFC, C, and BAC are all Zacks Rank #3 (Hold).
Net interest margin & Provision for loan loss:
One positive for the large banks rests in net interest margin. With treasury yields rising, net interest margins may have been supported. The graphic following displays the pressure on net interest margin since early 2010. However, net interest margin has stabilized in recent quarters, and may have a chance to uptick in Q3 and Q4 due to the rise in rates.
In contrast to net interest margin, provision for loan loss for the major banks is nearly back to the levels seen before the Great Recession. There is some room for loss provision to inch lower, but this item on the income statement is likely to start ranging. This will put a cap on earnings.
The table below displays the level of loan loss provision and net interest margin for the banks. Notice that the loss provision numbers from JPM and WFC were especially low last quarter. It is harder to get a read on net interest margin, but BAC has seen a lift recently. JPM has seen some pressure.
One of the negatives for the large banks rests in shrinking revenues. Revenue growth is projected to contract for the big four U.S. banks. Dodd Frank, capital requirements, a still weak real estate market, and a general cautious view toward debt are headwinds to revenue growth.
Earnings for the financial sector can be noisy. As a result, many investors use tangible book value to value banks. Tangible book value is a proxy for breakup value. Based on this measure and Q2 asset valuation, WFC is the most expensive bank with a price to tangible book value of just over 2.0. C is the most inexpensive with a price to tangible book value of 0.95. The graphic displays the trend in tangible book value per share for the banks. Notice that the valuations have been lifting in recent years but remain well below the levels seen prior to the Great Recession.
Banks look inexpensive relative to the past 10 years, but valuations are being restrained by the regulatory and slow growth backdrop. One example rests in a recent wire story highlighting JPM's exit from payday, certain auto dealer, and pawn shop lending activities. JPM is also moving out of the physical commodity and student housing businesses. Growth opportunities seem to be shrinking from a political perspective. The positive for the banks may rest in higher interest rates which are able to expand net interest margins.
Given the headwinds to profit growth, it may also be worth taking a look at the sector's PEG ratios - price to earnings ratio divided by the growth rate. There are some distortions given the impact of the Great Recession on earnings and the growth rate in earnings. However, the data is provided with a number of data points from C excluded because of not meaningful data (these are the gaps in the chart).
The PEG ratios for BAC and C are at a slight discount to their 10 year median, while the PEG ratios for WFC and JPM are at a premium. JPM looks most expensive. Although WFC is trading at a large price to book value relative to the group, its PEG ratio is reasonable. WFC also has the highest dividend yield of the group.
Conclusions - go the Europe :
Large banks are seeing pressure on their earnings estimates and profits are unlikely to find support from already low loan loss provisions. Expanding net interest margin may be the best hope for strength if interest rates can continue their rise and the economy can expand at a healthy rate. Valuation in the sector is cheap on the basis of price to tangible book value, but much less so based on the PEG ratio. Slow global growth and regulatory headwinds are weighing on growth and valuations. Given the valuation and growth picture, BAC or C may be the best bets on hope for turnarounds and normalization in the financial sector. WFC is attractive for its dividend, and JPM is somewhere in between.
Those looking for a play in large financial institutions may take a look at Deutsche Bank ( DB ) and Credit Suisse ( CS ). Both these names offer strong upward momentum to earnings estimate revisions, and also have favorable technical set ups. They were recently highlighted in " 3 Financial Charts to Bank On " http://www.zacks.com/stock/news/111369/3-financial-charts-to-bank-on
Further, DB and CS are trading at discounts to their median price to tangible book values. DB and CS have price to tangible book values of 0.83 and 1.13 respectively. Their ten year medians are 1.27 and 1.88 respectively. The PEG ratio for DB is 0.59 compared to 0.88 for CS. Lastly, DB has a dividend yield of 2.11%. CS does not pay a dividend. DB is trading below its tangible book value and under its growth rate, while paying a nice dividend.
Bottom line: Those looking to invest in large banks may want to go to Europe where there is better value and a stronger earnings outlook. DB and CS are both Zacks Rank #1 (Strong Buy) stocks. DB seems the most attractive.
BANK OF AMER CP (BAC): Free Stock Analysis Report
CITIGROUP INC (C): Free Stock Analysis Report
CREDIT SUISSE (CS): Free Stock Analysis Report
DEUTSCHE BK AG (DB): Free Stock Analysis Report
JPMORGAN CHASE (JPM): Free Stock Analysis Report
WELLS FARGO-NEW (WFC): Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research