Pessimism Reigns On Bank Stocks - Bank Of America Continues To Be An Example

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Includes: BAC, XLF
by: John M. Mason

Summary

Bank of America continues to get hit with "charges" that relate to bad management practices but under the leadership of Brian Moynihan the bank doesn't seem to be gaining control.

The question can be extended to the industry where banks continue to be selling at stock prices below book prices, an appraisal that doesn't say good things about bank sector.

Furthermore, the Federal Reserve continues to regard the banking industry as weak and continues to treat banks as if they may still be on the edge of solvency problems.

The word is that Bank of America (NYSE: BAC) is going to be paying the Securities and Exchange Commission somewhere around $400 to $450 million because it "violated rules designed to safeguard client accounts."

If this does take place, it "would make the accord one of the largest ever for the SEC."

BoA and the SEC have been going at this since April 2015. The practices in question appear to have been a part of trades conducted by BofA from 2009 to 2012.

The problems of Bank of America just seem to linger and continue on without end.

This, to me, raises further questions about the leadership of the bank, beginning with current Board Chair and CEO, Brian Moynihan.

Yes, Moynihan took over from the infamous Ken Lewis who was the Chairman and CEO of BofA from 2001 until the end of 2009. Lewis was a disaster for the bank and left Moynihan an organization that was in very, very bad shape.

The question about Moynihan is, why is the bank still is such a bad condition.

Moynihan is in his seventh year at the helm. And, the problems don't seem to go away.

The price of the bank's stock is slightly lower now than it was when Mr. Moynihan took over. In 2015, the bank reported a return on shareholders equity of 6.2 percent, its highest return since 2007, although analysts are expecting that the ROE will drop back a little this year.

The fact is that in terms of corporate turnarounds, time has run out.

Although Moynihan has talked about the bank in positive terms, the performance is not there and the continued "surprises", like the bout with the SEC, don't seem to want to let up.

The shareholder's of Bank of America seem to be unimpressed with his leadership and, although the stock price is only slightly lower than where it was when he took over, there is a real lack of enthusiasm in the stock market for the job that has been done.

But, it is not just the stock price of Bank of America that is lagging. Most US banks seem to be having that problem.

John Authers writes of this in the Financial Times: "Pessimism Reigns on Bank Stocks But Yields May Tempt."

The gist of this piece is that "US banks can mostly be bought for less than their book value" so might this be a good time to buy bank stocks.

The reasoning about the timing is that it is the yield on bank stocks that might make the purchase of bank stocks appealing. "The MSCI World Banks Index, covering banks across the developed world, yields 3.82 percent."

The yield on the 10-year German bund is near zero percent. The yield on the 10-year US Treasury note is around 1.70 percent. And, the bank yield is now "slightly more than the world utilities sector."

The issue here, to me, is that bank valuations are generally below book value. Authers writes "US banks can mostly be bought for less than their book value (about 0.92 times book, down from 1.1 times book a year ago."

He goes on, "European banks can be bought for far less. This even though, as Morgan Stanley points out, the health of the assets on their books appears to be improving, with net charge-offs at their lowest in over a decade."

This is what is troubling…bank valuations are generally below book value. And, this has been a problem for most of the period of economic recovery since the end of the Great Recession. The price-to-book value of banks has hovered around 1.00 times book, but has spent the majority of time below parity. Only during "false runs" has the price-to-book value risen above parity.

There is a two-fold concern here. The first has to do with the value of the assets. Are investors saying that they really question the value of bank assets and that banks are carrying assets that may not, in the end, be equal to $1.00 on a $1.00 of loan?

For one, I still have problems about he condition of lending in the commercial real estate area. I have written about this for much of the current economic recovery. Here is my latest estimate.

Authers writes that one of the near-term Federal Reserve tests of the banking area is the results of the stress tests for US banks that will be forthcoming next week. "This includes ruling on their requests to pay dividends and return capital."

Following onto this effort is the fact that the Federal Reserve is still keeping $2.4 trillion in excess reserves in the banking system. This number is down only slightly from the $2.8 trillion peak reached on October 15, 2014, just at the end of the Fed's third round of quantitative easing.

The Fed is not in any hurry to reduce the amount of excess reserves in the banking system and has vowed to keep its securities portfolio at the level it reached during the economic recovery until officials believe that it can safely begin "open market operations" again.

Here is a very Fed that is very sensitive to the "health" of the banking industry, not wanting to prematurely "tighten up" on bank reserves as it did in 1937 by reducing excess reserves before the banks are ready to relinquish them.

In other words, the Federal Reserve still must believe that the banking system is "weak" enough that it needs to keep excess reserves around the $2.4 trillion level in order to avoid any possible reaction on the part of the banks if the Fed began to remove reserves through open market operations at this time.

Or, the Fed doesn't want to "test" the solvency of the banking system at this time.

Then there is the Fed's backing off from any interest rate increase at the present time, even through its "forward guidance" over the past twenty months has been that it expected to raise rates at a steady pace. This, of course, continues to compress the bank's net interest margins and keeps lots of pressure on them to generate profits.

And, finally, we get back to the Bank of America situation again. Many other banks continue to experience problems with the regulators. Banks still seem to be paying for the mismanagement of the previous period of financial engineering within the banking area. These costs do not appear to be going away.

Overall, banking does not seem to be going anywhere. Are banks a potential "value investment" as Mr. Authers suggests they might be? I wouldn't put my money there.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.