4 Financial Stocks May Sink On New Regulations In 2013

Includes: BAC, C, GS, JPM
by: Investment Underground

by Matthew Smith

It is no surprise that the fallout surrounding the $2 billion trading loss at JPMorgan Chase (JPM) would be around for a while. There was also little doubt that it would bring up a lot of the conversation that occurred after the financial crisis in 2008 regarding risky trading undertaken by big banks. This is exactly what banks did not need, especially with all of the current constraints on the growth of the industry. Even with all the problems recently incurred, JPMorgan has regained some of its stock value. It has still avoided the bottom end of its 52 week range, and actually had a fairly solid month of June. I don't believe it will completely gain back what it lost, but it is making up ground, slowly and surely.

If you are reading about JPMorgan, it is likely that you have heard much about the huge trading loss already. It has opened up the regulatory conversation once again. At CEO Jamie Dimon's hearing in front of Congress, there was renewed sentiment about regulating a currently unregulated derivatives trading market. One of the main drivers of the sentiment was the fact that although JPMorgan can absorb a $3 billion loss, any smaller or less secure bank would be crushed, or fail completely.

One can see this idea in the loss in stock price that its main competitors Bank of America (BAC) and Citigroup (C) incurred following the announcement of the trading loss.

JPMorgan is looking to change things up and make sure this does not happen again. Specifically, the company is restructuring the very department where these bad trades originated. Notably, the company does not intend to cut back its exposure to risk in this unit as many believed it would, but it actually intends to increase its risk management.

It is widely known that the economy is growing at a sluggish pace and that many banks are facing many constraints, including European exposure and low interest rates. The banks who were downgraded criticize this move as backward looking. With increasing regulation pending, the last thing banks want is a lower credit rating to hamper their growth prospects.

The biggest problem for large banks regarding regulation is the required increase in capital. This is causing many of the large banks to cut back on lending to consumers, typically a reliable source of revenue. There are many regional banks that are willing to pick up on this lending, essentially replacing much of the business done previously by larger banks. Being that many of the larger banks suffer from poor customer service, it will take a lot to get this business back if the time ever comes.

With many of these concerns being industry wide concerns, its main competition is suffering just as much. Take Citigroup, for example. After the announcement of its downgrade from Moody's it lost over $1 on stock price initially, with it remaining on a slow descent. One bit of good news for Citigroup has been the purchase of part of Societe Generale's shipping portfolio. Societe Generale sold part of its portfolio to limit is exposure to Europe. In general, these loans are considered to be good quality loans and should bring stability to Citigroup's portfolio. Additionally, due to the need to get rid of many of these loans, it is assumed that Citigroup has picked up these loans cheaply.

Bank of America is facing many of the same pressures as JPMorgan. To become a leaner, more efficient bank, it is looking to sell its international wealth management business. At the same time, Julius Baer Group is interested in buying Merrill Lynch, which has caused Bank of America nothing but headaches. With proprietary trading inching closer to regulation, Bank of America needs to increase its focus and boost profitability. With that said, I do not expect Bank of America to meet its price estimate any time soon.

Wells Fargo still has a pretty solid price estimate of about $37. There are different ratings across the board, and many companies have conflicting views on Wells Fargo. Overall, I believe Wells Fargo is a safer bet due its stronghold on the consumer home lending industry. It should be noted that it is attempting to increase this stronghold even further.

Competitor Goldman Sachs (GS) has seen a significant portion of its stock price shaved since mid-March. It has been working hard to regain the bullish outlook through commodities, which has reportedly given it a 29% return in 12 months. With this return it is no wonder that three of the aforementioned banks, JPMorgan, Bank of America, and Citigroup, are also trying to get a piece of the commodities market. None of these three banks have reported similar returns, but with Goldman Sach's anemic stock price (over $98), I don't think investors see commodities as a savior.

JPMorgan has a lot going against it right now. I believe it has made many of its problems worse. Regulation was already poised to cause negative effects, but with the trading loss, it likely amped up the drive for more regulation. Add that to the recent downgrades, and JPMorgan does not look like a good investment. There are certainly better banks to back, as JPMorgan is looking less and less likely to hit any $40 plus price targets this year. I say stay away until the dust clears.

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