By Larry Gellar
With JP Morgan Chase & Co. (JPM) releasing a better than expected earnings report Friday, there is now significant pressure on other financial companies to also have strong earnings. Let’s take a look at five bank all-stars that are releasing earnings in the period from July 15th to July 21st.
Citigroup, Inc. (C) released earnings on July 15th. For the sixth quarter in a row, the company made a profit. Additionally, the company beat analyst expectations, but there is certainly one caveat to be had. The company did not need to use some of the money it had set aside for bad loans, so that money was actually counted as income. While this is obviously not a bad thing, it is a bit confusing because the money that was set aside was probably not generated this quarter. Citigroup’s financial supplement did not spell out the company’s cash flows for the past quarter, so look for this information to be rather valuable once it is determined.
Also of interest is that Citigroup experienced growth in both its consumer and corporate loans, much of it being from emerging markets. This is important because it shows the company’s strength in places that aren’t as affected by U.S. or European debt problems. Even if those issues are resolved in the near-term, a presence in the emerging markets is crucial considering the sluggish pace at which the U.S. economy is recovering. On the other hand, Citigroup did not fare as well as JPMorgan in its trading income, which suggests that JPMorgan’s strong trading income may not be representative of all banks.
Another point of interest is the P/E ratio of Citigroup compared to JP Morgan Chase. Specifically, Citigroup currently has a P/E ratio of 12.84, whereas JPMorgan’s is 8.86. In some ways, this is surprising considering how much government assistance Citigroup has needed. Although some aspects of Citigroup’s business certainly look promising, it appears that the market has already taken account of this and priced the stock up accordingly. At its current price of a little over $39, a recommendation of Hold seems most appropriate.
Bank of America Corporation (BAC) will be releasing earnings on July 19th. BAC stock has been setting new 52-week lows in the past few days, so this will certainly be an important earnings report for the Charlotte-based bank. As discussed in this article, the most recent problem with Bank of America has been its settlement regarding mortgage-backed securities. Specifically, there are six Federal Home Loan Banks that may oppose the settlement due to the lack of information it provides. Aside from the problems regarding mortgage-back securities, other issues can be found in the mortgages themselves as well as improper foreclosures.
Overall, an investment in BAC figures to be quite risky. However, another way to consider Bank of America’s situation is through a look at its book value per share. Bank of America, currently trading slightly above $10, has a book value per share of $21.15. Clearly, a situation where a company is trading below half of its book value per share is beyond remarkable. In fact, if the company can manage to put out a decent earnings report next week, there is a potential for some serious upside.
Like Bank of America, earnings for Wells Fargo & Company (WFC) will also be released on July 19th. Luckily for shareholders, the company has enjoyed a bit less bad publicity than some of its rivals. In fact, the company was recently ranked first in overall technical quality for the retail part of its web site. From a statistical perspective, the company’s operating margin is also quite solid, currently 33.91%. There is even a report that Wells Fargo is bidding on the credit card holdings of HSBC (HBC). With all this positive news, it is hard to believe that WFC will benefit from a strong earnings report as much as the banks that are in dire need of some good news.
Wells Fargo will also benefit from a recent decision to sell one of its tax / brokerage units. As discussed in this article, the firm H.D. Vest Financial Services was no longer a good match for Wells Fargo once it acquired Wachovia. Additionally, Wells Fargo plans to hire 175 new employees in Idaho – proof that this company is still finding ways to expand in this tough economy. As far as the actual earnings go, even the lowest estimates for WFC are significantly above what it put out last year, so chances are this report will be received favorably. Look for WFC stock to retain its consistency in the coming weeks, but keep in mind that it is still vulnerable to systemic problems, like the U.S. debt ceiling and debt problems in the eurozone. Wells Fargo also has its share of exposure to the mortgage market, so the stock is certainly not free from risk.
There is also one specific development that might hurt banks like Bank of America and Wells Fargo. Beginning in October, the amount of revenue that banks can collect from merchants when they accept debit card payments will be capped. As reported by the Associated Press, a recent poll shows that if banks try to impose a monthly fee to make up for this lost revenue, consumers will simply choose other methods of payments.
The Goldman Sachs Group, Inc. (GS), too, will be releasing its earnings report on July 19th. The stock is trading awfully close to its 52-week lows, and shareholders will certainly be hoping for a positive earnings report. The nature of JP Morgan’s earnings report is actually one thing that could help out GS stock until the earnings report comes out next week. Although JP Morgan’s earnings report was better than expected overall, the company did not fare well in a category called NIM, or net interest margin. Further information can be found in this article, but essentially, the reason the bank’s earnings were so strong is because of its work as a broker-dealer. Goldman Sachs’ significant amount of business in brokering and dealing leads one to believe that Goldman Sachs also will have strong earnings. Citigroup’s strong earnings in its investment banking division is another piece of news that should forebode well for Goldman Sachs.
As explained in the previous paragraph, JP Morgan’s success as a broker-dealer also forebodes strong earnings for Morgan Stanley (MS). Two days later than rival Goldman Sachs, Morgan Stanley will be reporting earnings on July 21st. One take on Morgan Stanley though points to the possibility of some negative news when MS reports earnings. In the graph presented by this article, one can see quite clearly that estimates for Morgan Stanley’s earnings have tanked in the past month. The price for MS stock had also been deteriorating in the months prior to this though, so it seems unlikely that there is a value play to be made on the sell side. If estimates for Morgan Stanley’s earnings have been revised too far downward, the stock will certainly have some upside.
With both Morgan Stanley and Goldman Sachs trading around 52-week lows, investors will surely be trying to figure out which one is the better buy once these two companies release earnings next week. When trying to differentiate between the two, keep in mind that Morgan Stanley has 62,494 employees, whereas Goldman Sachs has only 38,300. The two companies’ P/E ratios are also somewhat different (at least until next week’s earnings report) with MS coming in at 10.29 and GS coming in at 14.25.
At this point, let us consider a couple of scenarios that might unexpectedly help financial companies. Although it is hard to imagine the U.S. actually defaulting on its debt, there is one way that a default might actually be profitable for banks. As explained in this article, if the U.S. defaulted and the credit rating of its bonds were decreased, there would be an increase in sales and trading due to some contracts requiring a bond of triple-A status.
It is also worth noting that banks would stand to benefit from a third round of quantitative easing, even aside from any positive overall economic implications that it might have. Although Ben Bernanke’s most recent comments downplay the possibility of QE3, the fact that this is even being discussed is of interest. Specifically, the above financial companies would benefit because quantitative easing facilitates risk-free arbitrage. If QE3 is enacted, banks and other institutions will know that they have at least one buyer to sell their bonds to. For more information on how this works, consider reading this.
There are also two headlines that may affect the financials negatively. One economic condition recently in the news has been consumer sentiment, which measures how Americans feel about the economy in general, as well as economic prospects a year from now. Both were down by significant amounts since June. This hurts the financial sector greatly considering how sensitive these stocks are to the overall economy. Note that Bank of America and Citigroup have betas of 2.40 and 2.62 respectively. S&P’s recent announcement that the debt ceiling stalemate could cause them to downgrade the ratings of financial institutions is another piece of news that should be considered by investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.