Welcome back to December! Remember when the financial markets thought the Federal Reserve was going to raise interest rates three times or maybe even four times in 2016 and suddenly bank stocks were the thing to own? (At least until January when the Fed pulled back from its three or four times language and the market decided that one or none was more like it for interest rate increases in 2016 and sent the sector into a dumpster.)
Well, the positioning was back today–even if just for a day. After last week’s minutes from the April meeting of the Federal Reserve and after jawboning by half the Fed board of governors (it seems), financial markets have decided that a June interest rate increase could be back on the table–odds are now up to 36% from 4% before the release of the Fed minutes–and if not June then quite likely July–odds for a July increase climbed to 54% today.
That was more than enough to help the Standard & Poor’s 500 stock index to a gain of 1.4% as the index tacked on 28.02 points to hit 2076.06, comfortably, again, above the 2050 level that triggers worry that the S&P 500 is going to break through the bottom of its recent trading range.
The way upward was led by, you guessed it, banks as the SPDR S&P Bank ETF (KBE) climbed 1.86% led by stocks such as Morgan Stanley (MS) up 2.16%, JPMorgan Chase (JPM) up 1.7%, Bank of America (BAC), up 1.45%, and Capital One Financial (COF), up 1.37%. (Capital One is a member of my Jubak Picks Portfolio.)
The logic here is that bank earnings will climb if the Federal Reserve raises interest rates since that would increase the interest rate that banks can charge on their loans.
Of course, the growing conviction that the Fed will raise interest rates sooner rather than later (just two weeks ago you had to go out to February 2017 (and not July 2016) to find a Fed meeting that got better than 50% odds for an interest rate increase) took its toll on other sectors today. Gold fell another 1.8% to $1232 an ounce to set its longest losing streak since November. The dollar held near its recent two-month high against the euro.
There’s been precious little staying power to any market trend recently and today’s love affair with banks may prove to be short-lived as well. At an investor day event today Wells Fargo (WFC) lowered its projections for its 2016 return on assets to 1.1% to 1.4% from the 1.3% to 1.6% it projected at its 2014 investor day. For the full 2016 year the bank is now looking for a return on equity of 11% to 14%, down from 12% to 15%.
The big culprit is the bank’s large portfolio of energy loans and the company told investors it was taking steps to reduce the size of its portfolio of those loans. Wells Fargo said it had cut credit lines on 68% of the energy companies it had reviewed.
But it’s what the bank said about its net interest margin that might have the most impact on a continued bank stock rally. Because Wells Fargo, like many banks, has moved to reduce risk in its portfolio, it now expects that a 100 basis point upward shift in the yield curve after a Federal Reserve interest rate increase would add 5 to 15 basis points to its net interest margin. Previously the bank had estimated that a 100 basis point shift in the yield curve would add 10 to 30 basis points to its net interest margin. (100 basis points equal one percentage point.)
So here’s how this earnings season is playing out so far in the banking sector.
Beat really grim forecasts for earnings and revenue in the first quarter, shares go up–see JPMorgan Chase (JPM) yesterday.
Come close to those grim estimates, and shares go up–see Bank of America (BAC) today.
Beat grim projections, but show trouble in a core business, and shares move down, slightly–see Wells Fargo (WFC) today.
What we haven’t seen to date is the market’s reaction to a high-flying growth stock missing forecasts. That’s still to come.
Back to banking.
Adjusted earnings per share at Bank of America fell to 20 cents for the first quarter. That’s down from 25 cents a share in the first quarter of 2015, but only a penny short of the average estimate among Wall Street analysts.
Revenue dropped by 6.7%, falling below the $20.4 billion estimate on Wall Street, as revenue from trading operations dropped 16%. Investment banking fees fell, leading to a 22% retreat in the global banking division.
The one bright spot was consumer banking were profit rose 22% on a cut in expenses Profit at the wealth management division, which includes Merrill Lynch, rose 13% as lower expenses offset a drop in revenue.
And, as at JPMorgan Chase yesterday, Bank of America put aside another $525 million in loan loss provisions for its energy portfolio. That brought the loan loss provision for energy loans to $1 billion as of March 31. At the same time the bank reduced the size of its energy loan portfolio by $325 million from the first quarter of 2015.
Wells Fargo showed better results than Bank of America or JPMorgan Chase–except in its energy loan portfolio. Which is a big deal since Wells Fargo is Wall Street’s top oil and natural gas lender.
Earnings per share slid to 99 cents a share from $1.04 a share in the first quarter of 2015. That was 2 cents a share above Wall Street estimates. Revenue grew by 3.8% to $22.2 billion, beating analyst estimates for $21.6 billion in revenue.
The big red flag, completely expected, came in energy lending where the bank set aside another $500 million (a popular figure, no?) in provisions against bad loans in its portfolio of energy loans. Wells Fargo had $17.8 billion in outstanding loans to the energy industry, about 2% of its loan portfolio, at the end of the first quarter. (In addition Wells Fargo paid $1.2 billion in February to resolve government claims related to its mortgage practices from 2001 to 2010.)
In other, but very related news JPMorgan Chase, Bank of America, and Wells Fargo were all among the too-big-to-fail big U.S. banks to have their living wills rejected by the Federal Reserve and the Federal Deposit Insurance Corp. The banks, along with State Street and Bank of New York Mellon were told that their plans for entering bankruptcy in the next financial crisis were not credible. The banks have until October 1 to rewrite their plans or face the possibility of higher capital requirements. Among the eight too-big-to-fail banks only Citigroup’s plan earned a grudging pass from both regulators although even Citigroup was told it needed to improve its plan. Goldman Sachs and Morgan Stanley received a pass from only one of the two regulators.
Citigroup (C) is scheduled to report on Friday; Morgan Stanley (MS) and Goldman Sachs (GS) will release results next week.
The market’s first take on the Federal Reserve’s stress test of U.S. banks has been to divide bank stocks into “naughty” and “nice.”
But I’d like to dive a little deeper and look at how banks that have been told by the Fed that they can pay out more on dividends or increase their programs of share buybacks have chosen the divide those payout streams. That’s because I think investors get a lot more reward from a dividend increase than they do from a buyback. It makes sense, to my way of thinking, to go with the banks that emphasize dividends over buybacks—all else being equal, of course.
In the market’s first cut on the Fed list banks such as Bank of America (BAC) that have received the Fed’s stamp of approval on their capital plan for stock buybacks and/or dividend increases have seen their share price move up today. Bank of America shares, for example, closed up 3.8%.
Banks that got a thumbs down from the Fed and will have to resubmit their plans closed down today. BB&T (BBT), for example, finished off 2.36%. (It’s hard to say that JPMorgan Chase (JPM) was down today because the Fed told the bank to improve its capital plan. The bank and CEO Jamie Dimon took heavy fire yesterday from a Senate report that ripped the bank’s culture and risk controls in the London Whale trading debacle. JPMorgan Chase shares closed down 1.92% today.)
But the banks that got approval to increase their buybacks or dividends have put together very different mixes.
Some banks chose to increase their share buyback programs but not to increase their dividends. Citibank (C), for example, announced a new $1.2 billion program of share purchases but kept its dividend at a penny a share. That’s not exactly a rousing vote of confidence by the bank’s management in the bank’s cash flow going forward. It’s hard—and very visible—to cut a dividend once announced. It’s much easier to announce a big buyback program and then to execute only a part of it if times turn tough. Bank of America was another bank announcing a big buyback–$5 billion—without a dividend increase.
Most of the banks that got the Fed’s approval chose a mix of dividends and buybacks. Banks that wanted to send a message of confidence to shareholders seem to have picked an increase in the neighborhood to 20%. Wells Fargo (WFC) raised its dividend by 20%. US Bancorp upped its dividend by 18%. Both banks also announced buybacks. (US Bancorp is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/)
A very few banks went for all dividends. Capital One (COF) is the standout here. The bank announced a 500% increase to 30 cents from 5 cents.
The financial sector has been a clear leader in the rally to all time highs in the U.S. stock market. Right now I’d be looking at bank stocks where management is demonstrating a commitment to taking care of shareholders with higher dividend payouts.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any company mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
Forget about such nuanced worries as a declining net interest margin or a cut in share buybacks. Those are problems for investors in healthy banks such as JPMorgan Chase (JPM), Wells Fargo (WFC) and U.S. Bancorp (USB) to worry about.
Fourth quarter earnings announced today before the New York markets opened by Citigroup (C) and Bank of America (BAC) say that those banks have more basic problems: such as lower than expected revenue and a continuing drag from their mortgage business.
Citigroup reported earnings of 69 cents a share, 27 cents a share below the Wall Street consensus of 96 cents a share. Revenue of $18.66 billion was below the Wall Street projection of $18.85 billion.
The earning miss was a result of a continued parade of special charges including $1.3 billion in legal changes, a $305 million charge for settling mortgage claims with regulators, a $1 billion charge for previously announced layoffs, and a $485 million write down in the value of the bank’s own debt. Some of those charges were likely to be included in analyst estimates and some aren’t. That makes it hard to tell exactly how much of the apparent 27 cents a share miss was an actual miss.
One big surprise, though, came in the bank’s mortgage business. While banks such as Wells Fargo and U.S. Bancorp spent part of their recent conference calls talking about taking market share in the mortgage business, Citigroup seemed to be saying that, from its perspective, the mortgage crisis wasn’t over. The bank reported that it had released only $86 million in loan-loss reserves to earnings in the quarter. That’s a huge drop from the $1.5 billion release in the fourth quarter of 2011 and the $900 million release in the third quarter of 2012. The bank did continue to work down troubled assets in Citi Holdings, its bad bank. Assets in Citi Holdings fell $69 billion to $156 billion from the fourth quarter of 2011. At the end of the quarter, the bank’s Basel III Tier 1 Common Ratio was 8.7%.
Bank of America reported fourth quarter earnings of 3 cents a share, a penny above the Wall Street consensus. But the bank badly missed on revenue reporting $18.9 billion when Wall Street was projecting $20.72 billion. Read more
If this morning’s earnings report from Wells Fargo (WFC) was any indication, this isn’t going to be a very pretty earnings season for the shares of the largest U.S. banks.
Wells Fargo reported record net income for the fourth quarter and the full 2012 year, and record earnings per share of 91 cents. That was a 25% jump from the fourth quarter of 2011. Revenue climbed by 7% year over year. Deposits grew during the quarter by 3% and the bank’s core loan portfolio increased by the same percentage. Charge-offs against bad loans were lower by 19% from the fourth quarter of 2012.
And yet the stock closed down 1.12% because all that Wall Street paid attention to was the shrinking net interest margin at Wells Fargo. With the Federal Reserve doing all it can to bring long-term interest rates down, net interest margins—the difference between what a bank pays for the money it lends and what a bank gets paid on its loans—has been falling across the sector and is set to continue to fall. The net interest margin fell again at Wells Fargo in the fourth quarter, declining another 0.1 percentage point to 3.56%.
I think a lot of analysts share the opinion voiced after earnings by Credit Suisse that Wells Fargo is the “best positioned among our banks for rising short-term interest rates,” but with the Fed saying that it plans to keep rates at current low levels until 2015, I could hear the impatience in the conference call today. Read more