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.
Call the quarter grim but not disappointing. Which is good news as a whole for an earnings season with expectations for a 7% or larger drop in earnings for the stocks in the Standard & Poor’s 500.
This morning JPMorgan Chase (JPM) reported earnings of $1.35 a share,down 6.7% from the first quarter of 205. Revenue dropped 3%.
But both earnings per share and revenue beat Wall Street’s projections. Wall Street was looking for a 13.4% drop in earnings–so a decline of just 6.7% seemed remarkably positive. Revenue had been estimated to fall to $23.8 billion, so a fall to $24.1 billion also seemed to be positive news.
The shares closed up 4.23% today to $61.79 as both the Dow Jones Industrial Average and the Standard and Poor’s 500 rose (by 1.06% and 1%, respectively.) Before today’s rebound shares of JPMorgan Chase had been down 10% for 2016.
The beat on earnings was largely a result of cuts to expenses–and to trading revenue not being as terrible as the bank had warned in February. Non-interest expenses were down 7% on lower compensation paid to investment bankers and traders and lower legal cods. Pay in the investment banking business fell 14%, dropping more than $420 million from the first quarter of 2015. That month JPMorgan Chase had warned that markets revenue would drop by 20%. In actuality fixed-income trading dropped only 13% and equity trading dropped just 5%.
Looking ahead the bank flagged continue problems in its energy loan portfolio. JPMorgan Chase added $529 million to its loan loss provisions for oil, natural gas, and energy pipelines. That took the total loan loss provision for energy loans to $1.3 billion. The bank had told analysts to look for a $500 million addition to the loan loss provision for its energy portfolio. The bank also set aside $162 million to cover potential losses in its metals and mining portfolio. In February JPMorgan Chase had estimated that it would add $100 million to loan loss provisions for this part of its portfolio.
Financial stocks tend to do well as interest rates rise. What you’re looking for in this environment is a bank stock that is likely to show an increasing net interest margin.
Like Capital One Financial (COF). In the third quarter net interest margin rose to 6.73%, up 17 basis points from the second quarter. (100 basis points equal one percentage point.) And I think net interest margins will continue to climb in 2016 as the Fed Reserve starts to raise interest rates. Credit card lending accounts for about 40% of the company’s $213 billion loan portfolio (as of the end of September 2015). Credit card loans were up in the third quarter by 12% year over year. Credit card losses were up in October to 3.38%, a 26 basis point increase from September and the bank expects charge offs to climb through early 2016 before falling.
The company has made a number of acquisitions, which to me strengthen the company’s core rather than overwhelming the bank. In 2012 it acquired the ING Direct U.S. online banking business to become the sixth largest depositary institution in the country and one of the biggest online direct banks in the U.S. Recently the bank bought General Electric’s (GE) health care finance business and its $8.5 billion healthcare lending portfolio. That deal pushes Capital One into sector under represented in the bank’s asset portfolio. About 24% of the bank’s asset portfolio is made up of commercial loans but half of that is in real estate lending.
The stock is trading near the middle of its 52-week range (of $67.73 to $92.10) after a disappointing second quarter. A recovery that began with better than expected third quarter earnings of $1.98 a share, above the $1.95 consensus estimate from Wall Street analysts, has taken the stock back to a $79 close on December 9. The stock pays a dividend of 1.9% and sports a forward price –to-earnings ratio of 10.8%.
I will be adding Capital One Financial to my Jubak’s Picks portfolio tomorrow December 10. My target price is $88 a share by October 2016.
Which is what I make–a bank stock pick, that is–as part of my Sector Monday post today (yes, on a Tuesday) on my subscription site JubakAM.com. I’ll give you that pick on this free JubakPicks.com site tomorrow along with the reasons I like this particular stock.
But if you’d like to know more about what I look for in a bank stock in general, you’ll have to go to my paid site.
The post explains why it’s NIM–net interest margin–that counts and what to look for in a bank’s business model and loan portfolio to find the banks with the best opportunity to raise their net interest margin as the Fed raises its benchmark interest rate.
That’s what I’m working on at my subscription JubakAM.com site. (Tomorrow I begin a series of posts on the oil and gas sector.) I think there’s some value to you in passing on the direction of my thinking about the market on that site. Hope so anyway.
Of course, there’s an ulterior motive to sharing this with you: If you decide that you’d like more detail on my JubakAM.com posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)And th