>Updated with Monday comments on JPMorgan Chase from Credit Suisse analyst Moshe Orenbuch.
NEW YORK (TheStreet) -- It was a rocky second quarter for bank stocks, following what seems to have become an annual pattern for the sector.
The KBW Bank Index (I:BKX) closed at 45.79 Friday, down 8% during the second quarter, following a fat 26% return during the first quarter. On Friday, however, the index had recovered 12% from its second-quarter closing low of 41.00 on June 4.
In addition to weak investment banking and trading results, following a decent first quarter, there are several other major themes for the industry, heading into second-quarter earnings season:
HARP 2.0Banks with mortgage lending operations will report another strong quarter for loan originations and income from quick loan sales to Fannie Mae (FNMA) and Freddie Mac (FMCC), following President Obama's expansion of the Home Affordable Refinance Program, or HARP, which allows qualified borrows with mortgage loans held by Fannie or Freddie to refinance their entire loans balances, no matter how much the value of the collateral property has declined.
Sterne Agee analyst Todd Hagerman said on Friday that while he expects banks to report another strong quarter for mortgage loan originations, he expects mortgage revenue "to retreat somewhat" from the first quarter, because of last quarter's strong gains-on-sale. The analyst "also expects "diminished results from mortgage hedge gains will also likely be a drag on mortgage banking results given the relatively flat yield curve." Fannie and Freddie Putback Demands With Fannie Mae and Freddie Mac showing increased aggressiveness in demanding that mortgage loan sellers and servicers repurchase nonperforming loans, some of the major industry players are beefing up their repurchase reserves, including First Horizon National (FHN) of Memphis, Tenn., which on Thursday announced $272 million in second-quarter charges, after the company "obtained significant new information from Fannie Mae" on sold loans the company was no longer servicing." The consensus among analysts polled by Thomson Reuters is for First Horizon to post a second-quarter net loss of 50 cents a share. PNC Financial Services Group (PNC) of Pittsburgh on June 12 disclosed that it was experiencing "elevated levels of GSE-related repurchase demands" during the second quarter, primarily for mortgage loans originated from 2005 to 2008. The company estimated its new mortgage repurchase claims for the second quarter would total $288 million in the second quarter, increasing from $213 million during the first quarter and average quarterly putback demands of $193 million during 2011. PNC said that "As a result, PNC expects to add residential mortgage repurchase reserves of approximately $350 million in 2Q12." Analysts expect PNC to report second-quarter earnings of $1.26 a share, declining from $1.44 in the first quarter, and $1.67 in the second quarter of 2011. Industry observers will also be looking for clues from Bank of America (BAC) on how the company plans to move past its bitter dispute with Fannie Mae over mortgage putbacks. At this point, Bank of America has stopped selling mortgage loans to Fannie Mae, except for HARP loans, and FBR analyst Paul Miller said on June 22 that the company "is currently not paying claims from the GSEs per our sources," with the dispute centering on "whether the agencies can push back loans if the borrower remained current for two-plus years" before defaulting. Margin Contraction With short term rates remaining near zero and long term rates declining, there's a limit on most banks' benefits from declining funding costs, and deployment of increased liquidity into lower-yielding securities and loans is squeezing bank profits. Hagerman said his firm saw "interest margins falling by about 5bps, on balance, for our coverage universe," and that although "the q/q decline remains manageable in the near term (particularly with improved balance sheet growth expectations), commentary surrounding [net interest margin] outlook and the prospects for greater-than-expected margin pressure throughout 2012 will be a key focus in the quarter." Basel III and Trust Preferred Redemptions With regulators' new capital requirements -- based mainly on the Basel III requirements -- excluding most trust preferred securities from Tier 1 capital, many banks are now redeeming their trust preferreds at par value -- despite the sharp decline in interest rates since the trust preferred paper was issued -- because the securities' indentures allow redemptions at par under these circumstances. This will have the effect of mitigating some of the margin pressures, while, of course, forcing yield-hungry investors to scramble for new investments.
Just last week, PNC announced plans to redeem roughly $968 million in trust preferred shares, some of which had been originally issued by National City Corp., which was acquired by PNC at the end of 2008. Also last week, U.S. Bancorp (USB) of Minneapolis announced that it would redeem $500 million in trust preferred securities. A quick look at share valuations shows that investors continue to shy away from the nation's largest banks:
- Shares of JPMorgan Chase (JPM) closed at $35.73 Friday, returning 9% year-to-date, following a 20% decline during 2011. The shares trade just above their reported March 31 tangible book value of $34.91, and for less than seven times the consensus 2013 EPS estimate of $5.31. The company is set to report its second-quarter results before the market opens on July 13, with analysts expecting an 83-cent profit, declining from EPS of $1.31 the previous quarter and $1.27 a year earlier. The consensus EPS estimate for all of 2012 is $4.33. The big mystery for JPMorgan is just how much of a second quarter loss the company will show, after CEO James Dimon disclosed a hedge trading loss by its Chief investment Office (CIO) estimated at "slightly more than $2 billion." Dimon said that as the company wound down the hedge trading positions, the losses might climb higher, and the New York Times reported last week that cumulative losses from the trades could eventually total as much as $9 billion.
- Bank of America closed at $8.18 Friday, returning 48% year-to-date, after dropping 58% last year. Even with this year's recovery, the shares trade for just 0.6 times their reported March 31 tangible book value of $12.87, and for eight times the consensus 2013 EPS estimate of 98 cents. The company will report its second-quarter results on July 18, with analysts expecting earnings of 16 cents a share. The consensus EPS estimate for all of 2012 is 57 cents.
- Shares of Citigroup (C) closed at $27.41 Friday, returning 4% year-to-date Thursday, following a 44% decline during 2011. The shares trade for just over half their reported March 31 tangible book value of $50.90, and six times the consensus 2013 EPS estimate of $4.54. Citi will report its second-quarter results on July 20, with analysts expecting earnings of 89 cents a share. The consensus EPS estimate for all of 2012 is $3.93.
The following are earnings previews for the other 10 components of the KBW Bank Index trading below 10 times forward earnings estimates, as of Friday's market close, in descending order by forward P/E ratio:
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