Interest Rate Lift Off

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Includes: BAC, C, JPM, WFC
by: Millennial Investing

Summary

Big banks prepare for higher rates.

There's a lot of ways to play the banking space.

But at least one bank stands out for us, and a big-name investor.

Second quarter 2017 earnings reports rolled in with major banks reporting robust business in global banking. The growth in deposits, loans and credit cards will yield even higher revenues for banks when interest rates rise. Federal Reserve chair Janet Yellen expects the long-awaited interest rate lift-off to begin towards the end of 2017.

Bank Earnings Roundup

Strong demand for global consumer banking and wealth management/investment advisory services have helped some banks post record net income. Consumers are borrowing and saving more, and buying more on credit. Commercial borrowing also is on the rise. JPMorgan (JPM) increased its commercial loan portfolio by $200 billion. Yields on loans, though, are lower than banks would like.

Trading operations have come under pressure for the banking sector partly owing to lower volatility. The bank stocks, themselves, could benefit from steadier, more predictable stock prices.

Wells Fargo’s Rep Takes a Hit

Wells Fargo (WFC) is a favorite stock of Warren Buffett, yet even this famed value investor admits it was a “huge, huge, huge error” for the bank to not take immediate action when employees reported unethical behavior in customer accounts.

Despite being formally fined for a number of financial fraud scandals over the past year, the stock is still acting like a “quality” company according to value investment metrics.

Return on Equity (ROE)

2012

2013

2014

2015

2016

TTM

Bank of America

1.28

4.61

1.71

6.29

6.82

7.30

Citi

4.13

7.02

3.37

8.02

6.64

6.75

JPMorgan

10.72

8.40

9.75

10.34

10.27

10.58

Wells Fargo

13.16

13.99

13.68

12.78

11.78

11.64

Return on Assets (ROA)

2012

2013

2014

2015

2016

TTM

Bank of America

0.13

0.47

0.18

0.68

0.75

0.79

Citi

0.40

0.72

0.36

0.91

0.77

0.78

JPMorgan

0.86

0.70

0.81

0.91

0.95

0.97

Wells Fargo

1.32

1.42

1.36

1.24

1.10

1.07

Both Wells Fargo’s return on equity and return on assets ratios are above its banking peers, although they have been declining since 2016 (see tables).

In September 2016, Wells Fargo was fined $185 million for creating 1.5 million unauthorized checking and savings accounts, and 500,000 unauthorized credit cards. Another $50 million fine was levied against Wells Fargo for overcharging for appraisal fees for homeowners in default on their mortgages.

In 2Q 2017, Wells Fargo’s net income rose five percent to $5.8 billion. EPS rose six percent to $1.07. Revenues were $22.2 billion on flat growth. Deposits held steady while auto loans and community banking fell.

Earnings per share declined for the full year 2016 on a decline in net income. Operating margins have also been slipping since the fourth quarter 2016.

Wells Fargo’s price-to-book Ratio is 1.51, a rebound after falling below 1.30 in the fourth quarter of 2016 after the financial scandals were made public, and a tad above the bank industry P/B average of 1.1. Book value per share is 35.

Bank of America’s Super Hero Earnings Rise

Bank of America’s (BAC) global banking business posted record revenue of $5 billion in the second quarter of 2017 on higher investment advisory fees. Net income rose 10 percent to $5.3 billion. Global wealth management also posted strong profits. Sales and trading revenue dropped for a second quarter.

From 2012-2016, earnings have grown 460 percent to $17.9 billion. On a five-year basis to the end of 2016, the stock has returned 315 percent versus 168 percent for the banking sector, and 98 percent for the S&P 500. BofA repurchased $4 billion of its own stock in 2016.

Bank management is showing improving efficiency in its use of equity and assets for a third consecutive year (see tables).

BofA currently pays an annual dividend of $0.48 per share, a jump from $0.25 in 2016.

Bank of America’s price-to-book ratio is 1. Book value per share is low at 24 percent, about half the industry average.

Citi Group Beats the Street

Net income slipped 3 percent to $3.9 billion from the year-ago period while revenues jumped 2 percent to $17.5 billion. The global bank enjoyed growth across its loan businesses. Earnings per share increased 3 percent to $1.28. Earnings were impacted by higher credit and operating expenses.

Citigroup (C) engaged in $2.2 billion of share repurchases and dividend payments in the quarter. Citigroup’s price-to-book ratio is 0.9, indicating the stock is undervalued. Book value per share is a high of 77.

JPMorgan Posts Record Income

JPMorgan posted record net income of $7 billion and an EPS increase of 17 percent to $1.82 on strong growth in global consumer and commercial banking, and asset and wealth management. Revenues rose five percent from the year-ago period to $26.4 billion.

The investment banking division was number one in global IB fees in North America and emerging markets. Capital markets division revenue fell 14 percent to $4.8 billion. JPMorgan plans to repurchase $19.4 billion in stock over the next four quarters and increase common dividends 12 percent to $0.56. Both JP Morgan’s ROE and ROA are on track to post a fourth year of consecutive growth. JPMorgan’s price-to-book is 1.45, indicating the stock price is high relative to that of its peers. Its book value per share is 65.

Lift Off to Profitability

Analyst estimates of earnings growth show these banks are ready for lift off in 2018 as the Federal Reserve raises interest rates. Despite slower earnings growth relative to its peers ahead, Wells Fargo's strong operational efficiency (see ROE and ROA tables) still makes it Buffett's favorite value bank stock and worth a closer look.

Earnings Growth Forecasts

2017

2018

Bank of America

18

21.50

CitiGroup

10.60

13.20

JPMorgan Chase

9.70

12.10

WellsFargo

4.50

7.20

Source: Yahoo! Finance

Disclosure: I/we 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.