Investors get a plethora of earnings reports this week from the big bank / finance sector with BlackRock and JP Morgan kicking off results on Thursday morning, July 14th, 2016 and then Citigroup, Wells Fargo PNC Bank and US Bancorp reporting their 2nd quarter, 2016 results on Friday morning, July 15th.
Financials are the worst performing sector year-to-date (using the SPDR ETF's) with the XLF down about 4% versus the SPY's +3% to 4% total return as of Friday, July 8th, 2016.
Cons. Rev est
|y/y gro|| |
Cons. EPS est
|BlackRock (NYSE:BLK)||$2.81 bl||-3.5%||$4.80||-3%|
|JP Morgan (NYSE:JPM)||$24.16||-1.5%||$1.44||-7%|
|Wells Fargo (NYSE:WFC)||$22.2 bl||+4%||$1.01||-2%|
|Citigroup (NYSE:C)||$17.66 bl||-7.5%||$1.13||-22%|
|PNC Bank (NYSE:PNC)||$3.8 bl||-1.5%||$1.75||-7%|
|US Bancorp (NYSE:USB)||$5.19 bl||4%||$0.81||+1%|
Consensus estimate source: Thomson Reuters as of July 11 '16
How important is the Financial sector to the overall SP 500 ? Here is the blog post from this weekend talking about the importance of the Financial and Technology sectors.
The Financial sector is currently 15% of the SP 500's total market cap, but over 21% of the SP 500's earnings weight. Does that mean Financials are undervalued to that degree ?
Hardly, if readers just look through the above numbers, you can see there is very little growth in the sector, at least from the major names reporting this week.
My own opinion is the banks are still being overly-regulated thanks to the sins of the 1990's and 2000's and the Housing/Mortgage/Financial crisis hangover, and thus are having a tough time deploying capital to generate revenue growth.
And therein lies the rub: Financials are the worst performing sector year-to-date just eyeballing the SPDR ETF's (XLF, XLK, etc.) with Financials down 4% YTD in 2016 as of Friday, July 8th, while the rest of the sectors are up on the year.
The correction in the first quarter of 2016 (in my opinion) was led by collapsing crude oil and commodity prices, which put pressure on the lower-rated commodity companies with high-yield debt and also pressured some of the credit books of the larger banks. Remember, it wasn't just crude oil but the entire commodity complex which spiraled lower through February '16 and then started to bottom.
The point of this is that Q2 '16 earnings should benefit from credit spread improvement, particularly the capital-market sensitive names like JP Morgan, Citi and - to a lesser extent - Wells and UBS.
In addition, the 2nd quarter saw falling Treasury yields (again) which will help the banks with large mortgage books (like a Wells Fargo, and UBS) but the flattening yield curve offsets some of the benefits of the purchase and refi mortgage market volume.
Here is how the full-year consensus estimates look for the Big Banks / Financials reporting this week:
Cons rev est.
|y/y gro|| |
Cons EPS est.
|JP Morgan||$95.3 bl||-1.5%||$5.59||-7%|
|Wells Fargo||$89.3 bl||+4%||$4.07||-2%|
|US Bancorp||$20.86 bl||3%||$3.26||+3.5%|
Consensus estimate Source: Thomson Reuters as of July 11 '16
Just looking at the bigger, diversified, banks:
- Div yield - dividend yield: based on stock price 7/11/16
- PTBV - price to tangible book value: based on 7/11/16 stock price (Total Common Shareholders Equity less goodwill / intangible assets)
- ROTCE: return on tangible common equity: used a 5-quarter average starting with Q1 '15 through Q1 '16.
It is clear that because of JPM Morgan's earnings power and the dividend yield, the stock is not the discount to tangible-book value that the wounded franchises are that are Citi and Bank of America.
The CCAR (Comprehensive Capital Analysis and Review) and the Stress Tests results continue to crimp Citi and Bank of America, while JP Morgan is giving more latitude to return capital to shareholders and repurchase stock.
Conclusion: In Q2 '16, investors saw a nice pop in commodity prices, an improvement in the high-yield credit market, continued lower Treasury yields, with Brexit the only real "negative" shock but that correction was just 5% over a 2-year period and the US stock market promptly reobounded.
There is the continuing, looming Italian and German Bank issue, with the "CoCO" bonds from Q1 '16 (contingent convertibles) and now the property funds in the UK rearing its ugly head.
My own opinion regarding the big banks and other global financials is that as long as the regulators continue to hover over the institutions with CCAR, stress tests, living wills and such, every "crisis" will result in punishment for the sector since Financials, like Technology are one of the few sectors with substantial and pervasive reach through every sector of the US economy. Consumer, commercial, private sector, public sector: the US Financial sector is like the human heart, it pumps capital (i.e. blood) to every part of the US and global economy, thus with a string clamped tightly around the heart (financial system) growth and capital returns are lower.
Technically, JPM Morgan looks the best. A trade above $65 breaks the recent consolidation and JPM will likely make a run for the all-time-high's near $70. I do think JPM has the fewest regulatory issues, the broadest business model with diversified exposure to both the consumer and commercial loan growth, and an investment banking business that could benefit from the Q2 '16 credit spread and commodity improvement. JPM has been cautious about guidance and issued some updated guidance, but let's see what the numbers look like.
Wells Fargo needs to stay above $45. While the bank is generating positive revenue growth, the flat yield curve has to be playing havoc with WFC's gigantic mortgage origination business. WFC would benefit from a steeper yield curve, but that has been like "Waiting for Godot".
In Q1 '16 all of clients Bank of America position was sold since, the stock - despite its attractive price-to-tangible-book valuation offered no downside protection to the capital market's corrections. With a paltry dividend yield, clients were swapped into Goldman Sachs since the volatility seems to be the same, but the upside is limited.
While Wells Fargo is a fantastic institution and one of Mr. Buffett's favorites (Mr. Buffett and Berkshire recently asked to be allowed to buy more WFC since they are apparently at their regulatory limit), my own opinion is that JPM offers a more diversified business model that will retail and grow returns across all market environments.
Here are the primary themes found within Financial sector:
1.) Growth is limited, and revenue growth post-2008 has been low-single-digits for years.
2.) The regulatory "cuff" has stifled returns as ROE's (return on equity) have universally shrunk.
3.) In 2013, when the SP 500 returned 32%, Financials did outperform that year, but readers need capital market exposure to get that revenue benefit.
4.) Expense control is a bigger imperative with slower revenue growth.
Of the big banks and select Financials, JPM is still "best-in-show".
I'm looking for the 2nd quarter to show good results by the banks, although guidance will be tempered until the Street can put together a few consistent quarters of decent returns.
From the largest to smallest bank positions for clients:
1.) JP Morgan
2.) Wells Fargo
No positions in Bank of America or the other larger, mid-sized banks.
Disclosure: I am/we are long JPM, WFC, SCHW.
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.