Recent earnings data released by the major U.S. banks have painted a mixed picture. However, what looked promising after a long period, is that, they have now started showing positive organic growth. Stronger margins on the other side, pushed the revenue growth higher on a "still-challenged" balanced growth. Though in the near term, I expect the banking stocks to be wavy but they shall benefit over the long term with inflows from the equity funds as well as economic recovery. Additionally, their long growth will be supported by "broker-dealer revenues" as well as housing recovery.
In this article, I have tried to analyze the future outlook as well as the growth potential of the top three American banks. These banks are currently focusing on repairing their balance sheets by raising additional capital and improving funding profiles. Let's discuss each of them in detail.
Bank of America (BAC)
The Global Wealth & Investment Management (GWIM) business provides a bigger opportunity for Bank of America. The potential that lies here is that GWIM doesn't consume much capital and its ROTCE was 30.5% in 2012 up from 25.5% in 2011. I estimate that it will reach at least 31% in 2013. BOA's GWIM business is focusing on increasing broker productivity and improving operating efficiency. Total assets under GWIM are increasing and the Bank's revenue growth shall be enhanced by the higher AUM in 2013. I expect it can grow about 15% this year to $2.56 billion based on ~5% revenue growth. This shall give about $0.20 of EPS in 2013 and nearly 20% of firm-wide earnings before the preferred dividend.
On the other side, Bank of America's expenses will decline by 16% in 2012-2014. The company's projected cost savings of $8 billion by mid-2015 is on track. In stage one, the company expects to generate $5 billion of saving (~18% of total consumer operating expenses) and in stage two, the company shall generate $3 billion by 2015. To rebuild its earning power the management is planning to cut cost, concentrating on tail risk and shrinking the balance sheet.
I think the reduction in expenses, the legacy asset progress and core earnings power stories are taking the stock in the right direction. The recent pullback in BOA's price (from over $12 in early January), is providing a good entry opportunity currently in this stock.
Citigroup Inc. (C)
Mike Corbat, the new captain of the ship is looking to cut costs and will continue to pursue the ongoing re-engineering efforts. Citigroup is looking to trim down its costs by $900 million in 2013 (with an additional $1.2 billion in 2014) though some part of this amount will be mitigated by investments across the franchise. IFR settlement announced in early 2013 will result in lowering expenses. These expense savings will be offset by volume-related costs, particularly as it seeks to grow client volumes in the low-interest rate environment. To improve efficiency across the company Mike Corbat seeks to cut underperforming businesses and optimize the firm's business model. Although the initiatives will take off soon, the impact of changes shall be visible only in the coming quarters.
Citi results were burdened by higher legal expenses and reduction in its loan loss reserve. Looking at 2013, I expect the housing recovery shall continue to lift the NCOs (Net Charge-Offs) levels, which should accelerate substantial reserve releases. In 2013, I expect the legacy cost to decline and mortgage related reserve releases to occur ($8.4 billion reserve for $92 billion of loans). The Citi management suggested release of reserves would need to look forward for further economic improvement, including the resolution of the debt ceiling debate. Citi's reserve ratio is more than double its peers representing 9.1% of the mortgage loans total of $8.4 billion of mortgage related reserves. I see $0.19 per share of benefit from loan loss reserve releases in Q3 that plunged to $0.2 in Q4 due to higher provisions. I view the potential for reserve releases this year as a positive catalyst for the stock for this reason.
JPMorgan Chase (JPM)
Mortgage Banking continues to deliver
Mortgage Banking's performance remained strong in 4Q12 as revenue was up to $2.0 billion. In mortgage banking JPMorgan Chase's forecast remains strong in 2013 and sees long-term returns. The management is focusing on increasing its mortgage market share to 15% from 10%. JPMorgan Chase is also focusing on its profit on sale spread. Gain on sale margins fell from 3.42% to 2.95% in 4Q. In 2013, I see gain on sale margins continuing compressing another 70 bps. The mortgage business acts as one of JPM's best opportunities for growth as share gains should partly offset the lower gains on sales margin.
Expenses are well-managed
In 4Q12, expenses of mortgage related matters include Independent Foreclosure Review settlement. This will not recur in 2013 resulting in cost savings of $100-$150 million per quarter. With the IFR settlement, servicing expense should trend materially lower in 2013. Elevated litigation and default servicing expenses are now normalizing, which will further result in cost saving of $1 billion.
I am confident that mortgage banking shall continue to act as an inflow for JPMorgan Chase, in which the bank heavily participates.
I am bullish on all the banking stocks discussed above. Citigroup has an attractive franchise with good long-term growth opportunities in the emerging markets. While Bank of America due to its significant benefit from GWIM earnings and ongoing improvement of capital levels, remains a strong opportunity for the investors. Lastly, for JPMorgan I am confident that mortgage banking will continue to act as a tailwind to its earnings.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.