2 Overpriced Banks And 2 Stronger Options

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 |  Includes: BAC, C, WFC, XLF
by: Efficient Alpha

Consumer Credit for June is released at 3pm eastern time with the markets expecting an increase of about $10.0 billion. The report for May credit surged to $17.1 billion and beat all estimates surveyed by Bloomberg as a weak job market spurred borrowing. The rebound in consumer credit since the recession, now at almost 6% annual growth, is masking a much higher rate of growth in student loans versus slower growth in other types of non-revolving credit. Student loans accounted for approximately $6 billion of the $9.1 billion in non-revolving loan growth last month.

It does appear that consumer credit is strongly in its expansion phase as bank willingness to lend has increased over the past several months and housing looks to have bottomed. Though the financials still face increased regulation and scrutiny over recent problems, valuations are fairly low by historical standards. Still, investors should keep an eye on the credit report and Fed surveys each month for signs of a slowdown in lending and the general economy.

The Financial Select Sector SPDR (NYSEARCA:XLF) remains my favored vehicle for exposure without the risk of a company-specific blowup. The fund holds shares in 81 companies and is fairly well diversified across insurance (24.0%), commercial banks (21.2%), financial services (20.2%), capital markets (12.6%) and REITs (12.7%). Shares are relatively more expensive than individual names at 11.2 times trailing earnings but still trade under book value and pay a 1.7% dividend yield.

Citigroup (NYSE:C) was named in a case brought by Berkshire Bank last week over damages for alleged LIBOR manipulation. Plaintiffs in the case are sure to increase, and the Justice Department is preparing a criminal case as well. Despite possible headline risk leading to short-term price volatility, I think the case will ultimately lead to little more than a small fine for the bank. Earnings came in $0.11 stronger than expectations in the second quarter at $1.00 per share and $3.65 for the last four quarters. The shares trade cheaply for 7.5 times trailing earnings with a penny dividend for a 0.15% yield.

Bank of America (NYSE:BAC) reported a second-quarter increase of more than 40% in claims for refunds on faulty mortgages and said that the backlog of new claims suggests refunds will increase in the following quarters as well. The bank has put aside more than $40 billion to resolve disputes, but may need to add capital to it if claims increase further. Earnings came in $0.05 stronger than expectations in the second quarter at $0.19 per share and $0.93 for the last four quarters. The shares trade for 8.0 times trailing earnings with a penny dividend for a 0.5% yield. While the shares may not necessarily look expensive, earnings are notoriously volatile and could miss expectations in the coming quarters on developing refund claims.

Shares of Wells Fargo & Company (NYSE:WFC) have increased almost 50% in the last year on strength in the company's home lending business. The bank is the largest in the U.S. by market cap and recently reported plans to expand its workforce in Asia by at least 10 percent over the next three years. Earnings came in $0.01 stronger than expectations in the second quarter at $0.82 per share and $3.02 for the last four quarters. The shares trade for a relatively expensive 11.4 times trailing earnings and a 2.6% dividend yield. While I think the recovery of the housing market in the United States will help the bank outperform peers over the next few years, I am hesitant to buy in at these valuation levels.

I have long options positions in the Sector Fund for overall exposure and a position in Citigroup on valuation.

Disclosure: I am long XLF, C.