There was a solid article in this week's Barron's, an industry standard weekly magazine. Barron's interviewed Richard Pzena who is the CEO of Pzena Investment Management (NYSE:PZN); a firm that manages billions of dollars thorough a variety of entities.
Mr. Pzena made the long term case for owning some of the biggest banks. He believes three of the big drivers of earnings should improve significantly over the next couple of years.
- A current headwind for bank earnings is low interest rates which have confounded pundits in 2014 by declining significantly even as the economy seems to be accelerating recently. As a result, net interest margins are historically low. With the Federal Reserve finally ending its last quantitative easing program in October, interest rates should be nicely higher by the end of the year or early 2015. This should boost net interest margins and profits.
- Trading volume has shrunk substantially recently in recent years. This and additional regulation have driven much of the second tier players from this space leaving the lion's share to the bigger banks with major investment banking arms. When trading volume returns, they should do quite nicely with their increased market share. M&A and IPO activity are already robust.
- Both regulatory and bad loan expenses resulting from the financial crisis should drop in coming years, especially on the litigation front as the post-crisis witch hunt runs its course.
Mr. Pzena's logic on major banks is sound and is why I own a couple of the major banks he favors, Citigroup (NYSE:C) and Bank of America (NYSE:BAC). I prefer Bank of America and hold a bigger stake in this major banking play for several reasons.
The bank recently settled its outstanding mortgage issues stemming from the financial crisis with the Federal government for some $17 billion. I agree with Dick Kovacevich, the former CEO of Wells Fargo (NYSE:WFC), on the settlement being more about politics than justice as almost all the wrongdoing occurred at entities like Countrywide that happened before Bank of America was encouraged to acquire them. In addition, a nice chunk of settlement appears to be going towards the coffers of a variety of activists favored by the administration. This being said, the agreement does remove a huge overhang on the bank and its stock.
Mr. Pzena believes normalized earnings for Bank of America should be around $2.30 a share once the three factors outline above come to fruition. This could take several years to come to be but the consensus does have the bank bouncing back from a dismal 2014 earnings wise to post profits of ~$1.50 a share in 2015. This is the sharpest earnings growth projection of any of the major banks for next year.
The bank also recently got permission to quintuple its dividend payout from the Federal Reserve, as the company continues to slowly remove the tentacles of the government from its neck. Merrill Lynch has also started to move from an albatross to a core earnings driver. For long term investors, shares are offering a solid entry point at just over ten times next year's earnings consensus and for about book value. ACCUMULATE.
Disclosure: The author is long BAC, C.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.