Banking Year-End Surprises And Upsets

Includes: BBT, C, WBS
by: William Sterling

As I continue to look at year-end earnings releases for the nation's banks, one thing that is clear is that a majority of these banks have blown past their earnings estimates. Banks will likely be the strongest sector of the S&P 500 index by the time all the numbers are tabulated. Today, I am going to look at a couple of banks that have done well, and another that has not done so well.

Before going forward, I need to correct something I see widely disseminated. A bank's return on equity is not an appropriate measure of comparing a bank's earnings or their quality. For instance, large Canadian banks, such as Royal Bank (NYSE:RY) and The Bank of Nova Scotia (NYSE:BNS) do not typically carry the amount of shareholders' equity on their books that their U.S. peers do. Canadian Imperial Bank (NYSE:CM) had a ratio of shareholders' equity to assets of about 4.5% at the end of fiscal 2012. This well-run institution had a return on equity for 2012 of 19%. The slightly smaller U.S. Bancorp (NYSE:USB) earned far more money in 2012 than its Canadian competitor, $5.6 billion to $3.3 billion. But U.S. Bancorp, with its higher level of shareholders' equity, returned just over 16% on that equity. Returns on shareholders' equity is a meaningless number, absent background information, which is why I rarely if ever discuss it in looking at banks.

Citigroup (NYSE:C) reported year-end earnings, and dealt with what I hoped, but did not expect, new management to do. What they did is confront and write-off chunks of some of the questionable items still carried on Citigroup's balance sheet. Legal expenses in the fourth quarter grew by some $400 million from the year-ago quarter, largely on account of Citigroup's $305 million cash settlement of the omnibus mortgage foreclosure abuse case. The big bank also put another $900 million into its legal reserves, and took a $1.1 billion charge related to its workforce reduction of about 11,000 individuals. Despite all this, the bank's earnings came in at $2.2 billion, or $0.69 per share, net of non-cash accounting charges and a debit revaluation charge. This beat 2011's fourth quarter earnings of $0.38 per share, but still failed to meet analysts' expectations of $0.96 per share.

For all of 2012, the country's third largest bank by assets posted earnings of $11.9 billion, or $3.86 per share, for a 0.63 return on assets. This compares with $10.1 billion or $3.30 per share in 2011. Its Tier One common equity ratio ended 2012 at 12.7%, over twice what is considered "well capitalized," and its Basel III capital was about 8.7%. With these comfortable capital margins, Citigroup will almost certainly pass this winter's "stress test" and be allowed what it sought to do last year, buy back $8 billion of its stock.

Heartening to me is that after years of shrinking, in 2012, Citigroup, net of its steadily shrinking Citi Holdings unit, showed some growth. Deposits and core loans both grew by 7% from the end of 2011. Citigroup's net interest margin showed resiliency throughout the year, ending at 2.93%, the same as 2011. Citigroup's big investment bank also had a decent quarter, with its revenues up 47% from the year earlier. It also was awarded a co-lead of what may be the largest domestic offering for 2013, the Government's stake in General Motors (NYSE:GM).

Giving pause to Citigroup's immediate future was a comment made by its new CEO, "We've got to get to a point where we stop destroying our shareholders' capital," Corbat said. "We are not satisfied with these bottom-line earnings." The implication I take from this is that there will be more "destruction of capital," or write-downs, in coming quarters. Despite this, I am generally bullish on Citigroup's future. It has a PEG of 1.0, and there is a feeling that management "held back" on reporting better earnings this quarter by not releasing excess loan reserves. The stock price is about 8% of last decade's high price points, so there is a lot of room. Those who can afford to wait out the risk of a few more rough quarters might be interested in the strong growth potential of this equity over the long run.

One of the country's steadiest big banks in recent years has been North Carolina's BB&T (NYSE:BBT). It did nothing to disappoint in the fourth quarter, with earnings of $506 million, or $0.71 per share, a 29% jump from the fourth quarter of 2011's $391 million, or $0.55 per share. This was not a surprise; rather, income was right on target with predictions. But BB&T's revenue, which for nearly every other bank was coming up short of Wall Street forecasts, actually exceeded analysts' predictions there as well, with total revenues up 5% from the year earlier to $2.53 billion. Analysts had predicted $2.45 billion. For all of 2012, BB&T earned $1.92 billion, or $2.70 per share, compared to $696 million, or $1.83 per share, in 2011. BB&T's return on assets in 2012 was 1.14%, reaching 1.20% in the fourth quarter. Its efficiency ratio was a fine 54.3.

The success of the fourth quarter was revenue driven. BB&T is not a cheaply run enterprise, with nearly 1,800 branches across the mid-Atlantic and Gulf Coast states. Recent acquisitions of an insurance company and Bank Atlantic both assisted the revenue and earnings growth. I believe this fine bank is undervalued today, trading, for instance, at a PEG of 0.89. I expect low double-digit annual profit growth over the next several years, and that growth is not reflected in the stock price. I believe this makes a fine holding for a good many growth and income investors.

Northeastern regional bank Webster Financial (NYSE:WBS) continued the pattern of strong fourth quarter earnings for regional banks. It posted fourth quarter earnings of $48 million, or $0.52 per share, beating the fourth quarter of 2011 results by 21%, and even the third quarter of 2012 by eight percent. Commercial loans grew by 16% from a year ago, and the bank's return on assets peaked at 0.98% for the fourth quarter. Overall in 2012, Webster earned $171 million, or $1.86 per share, an improvement of 17% from 2011. By most measures other than stock price, Webster has fully recovered from its huge losses late last decade.

But with its net interest margin of 3.27% -- well below most well-performing regional banks -- and with a fourth quarter behind us, I just don't see a lot of growth in Webster over the next year or two. Its present price to earnings ratio is probably overextended, as it is trading at a PEG of 2.4. I do not recommend this stock at anywhere near the current price point.

Disclosure: I 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. I have no business relationship with any company whose stock is mentioned in this article.