Don't Miss These Rebounding Banks In 2013

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Includes: BAC, C, JPM
by: Fusion Research

Recently, Moody's changed its outlook for the banking industry from negative to stable. However, this changed outlook came late considering investors' confidence towards banking stocks, which have shown a positive run year to date. The question that arises is whether this improved outlook will further enhance investors' confidence in the banking stocks or not.

In this article, I am analyzing the top three U.S. banks, including Citigroup (C), JPMorgan Chase (JPM) and Bank of America (BAC). Let's see how these banks will perform after their first-quarter results.

Changing tax policy will help this bank

Citigroup changed its strategy of bringing income from international investments in the U.S. during the first quarter. For many years, Citigroup was benefiting from lower taxable income in the U.S., as it had classified some of its income from international investments as permanently reinvested income. The U.S. accounting rule exempts any taxation on income that is permanently reinvested in some other country. This strategy will make these incomes taxable in the U.S. also, but this additional taxable income will help it utilize its foreign deferred tax assets, or DTA. Currently, the bank has $55 billion of DTA, and this strategy will help it to utilize its DTA in the next five years.

In the first quarter, it posted net income of $3.8 billion, showing a rise of 31% year over year. This increase was due to the solid top-line growth in its securities and banking division that includes its advisory, underwriting, trading, and private banking units. In the first quarter, this division generated revenue of $7.3 billion, which is around 50% higher than its average revenue in the preceding three quarters. However, in the second quarter, its trading business is expected to generate revenue of $4.1 billion, showing a decline of 25% quarter over quarter because of the normal negative seasonality of the trading business in the second quarter. But, if we compare this quarter with the year ago quarter, the trading business is still expected to show growth of 20% year over year.

Going forward, the company will benefit from its increased focus on operating expense reduction and Citi Holdings losses reduction. In the fourth quarter of 2012, the bank decided to cut around 6300 jobs, which will generate savings of around $1.1 billion yearly from 2014. The bank is continuously downsizing its troubled portfolio under Citi Holdings, from around $900 billion in 2008 to less than $150 billion, which is a sign of turnaround for the bank. Going forward with the ongoing recovery in the housing market, Citibank will further see reduction in losses from this division.

Overall, I recommend buying this stock for the long-term growth.

Cost restructuring and increased investment business is the key

In the first quarter, JPMorgan reported a decline in its traditional banking business. The bank reported a net interest margin, or NIM, of 2.37%. That makes it the fifth continuous quarter in which its NIM has declined. In the first quarter, it experienced a shift in its deposits; its income bearing deposits increased by 4%, while its non-interest bearing deposits declined by around 5%. This resulted in higher interest payments and, combined with lower interest on loans, caused this decline in NIM. As the Federal Reserve has mentioned that it will keep the interest rate at the current level of 0% to 0.25% in the near future, JPMorgan's NIM will continue to decline for the upcoming couple of quarters.

However, the currently prevailing low rates also provide an opportunity for JPMorgan's Corporate & Investment Bank, or CIB, division, which contributes 40% of consolidated earnings. The bank experienced CIB revenue growth of around 10% until the middle of the current quarter year over year. Investors in the U.S. are looking for some higher yield investment avenues, which is resulting in increased demand of fixed income products and equity trading. It is expected that with this trend, CIB revenue will show growth of 5% year over year in the second quarter and will further experience 2% growth for the whole year.

The bank is also focused on reducing its cost in the difficult rate environment. In its CIB division, it is expected to save $300 million in 2013 from its "Strategic Re-engineering Program", which was started in 2008 and focused on improving front and back office systems and improving the bank's derivative trading platform. Furthermore, its decision of combining its investment bank, or IB division, and treasury & securities services, or TSS division, will help it to integrate its operations and international branches. This integration will produce savings of $350 million annually by 2015.

Overall, I recommend buying this stock for the long-term growth.

Cost restructuring is the key for success

In contrary to JPMorgan, Bank of America posted NIM growth of 0.08% in the first quarter. It had NIM of 2.43% in that quarter; the third consecutive quarter in which it posted growth in NIM. This is very good performance considering the fact that its operations are not as globally diversified as Citigroup -- that is the only other bank to post higher NIM in the first quarter.

However, in the near future, NIM outlook is challenging for the whole banking industry because of low rates environment. But Bank of America's cost saving plan will improve its bottom line in absence of higher margins. Currently, the bank is on track with its "Project New BAC", which was started in 2011. Under this initiative, the bank is streamlining its business processes. Its non-interest expense was $18.2 billion in the first quarter against $19.1 billion year over year, which is sign of the success of this initiative. This initiative is expected to generate savings of $8 billion annually by 2015.

In the short term, investors are worried about the decision of its Gibbs & Bruns consortium settlement. This lawsuit started when mortgage securities investors claimed that, Bank of America had breached provisions of the purchase and sell agreement, or PSA, and put its own interest before the investors' interest. Bank of America then reached a settlement and reserved $8.5 billion for this. The decision on this is expected within six months. It is expected that the bank will be able to get approval for this settlement, which will remove this ongoing headwind for earnings. As settlements like these are agreed upon by both the parties, these are generally approved.

Considering all these factors, I recommend buying this stock.

Bottom line:

Citigroup will continue to reduce its assets under Citi Holdings and its tax strategy will help it to utilize its DTA. JPMorgan will continue to benefit from its "Strategic Re-engineering Program" and its CIB division will see improvement in the trading business.

Bank of America is doing well with its "Project New BAC" initiative and is expected to offset any decline in the NIM from its U.S. focused operations. However, its currently ongoing final hearing of the Gibbs & Bruns consortium settlement is causing concerns for the investors, but it is expected to be in favor of the bank.

I recommend buying stocks in all three banking companies.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.