NEW YORK (
) -- UBS analyst Brennan Hawken on Thursday downgraded three of the largest U.S. banks and brokers on Thursday, while keeping the faith for two others.
"We are shifting to a more cautious stance on the sector, after the group has run up 31% since late July."
The analyst said that "in a more constructive environment for
capital markets, the average
returns on tangible equity for the group could move up to around 10% for next year... however, given a 12% cost of equity, this would mean the group is fairly valued at 0.82x
tangible book value."
In addition to "the regulatory/political uncertainty and impact of structural shifts in capital markets businesses," other concerns for the biggest industry players, according to Hawken, include "slower than expected reductions in legacy mortgage costs, weak consumer lending, the impact of European recession on universal bank
commercial and industrial loan growth, and potentially higher funding costs from the recently unveiled details of the FDIC resolution plans."
While it would have to be considered a long-term concern for the industry -- unless of course the coming election leads to the Democratic Party again controlling both houses of Congress, as well as the presidency -- FDIC Director Thomas Hoenig's proposal that banks enjoying the "public safety-net" of deposit insurance protection and access to the Federal Reserve discount window be
from the brokerage business, perfectly illustrates the political uncertainty cited by Hawken.
The prolonged roll-out of new rules derived from the Dodd-Frank Wall street Reform and Consumer Protection Act -- signed into law by President Obama in July 2010 -- represents the regulatory risk, with the overly complex Volcker Rule and proposed Basel III capital requirements at the forefront.
Regarding the recent market strength in the wake of additional stimulus actions by the
and other central banks, Hawken said that although the "actions may help drive earnings higher, particularly through capital markets operations, we felt that the stocks currently more than reflect the upside of this potentially improving earnings outlook," and that "even if the capital markets environment picks up dramatically, driving earnings forecasts roughly 20% higher than current levels, the stocks actually already reflect this higher level."
"In short, the universe has moved too far too fast, and now reflects a fairly optimistic outcome."
Here's a quick look at the three companies downgraded by Hawken, along with the two for which the analysts' ratings were unchanged:
from a "Buy" rating to a Neutral rating, while leaving his price target for the shares unchanged at $36.00.
Citi's shares closed at $33.94 Wednesday, returning 30% year-to-date, following a 44% decline during 2011. The shares trade for 0.8 times their reported June 30 tangible book value of $51.81, and for 7.5 times the consensus 2013 EPS estimate of $4.53 a share, among analysts polled by Thomson Reuters.
The company announced on Sept. 11 that it would record a pretax write-down in the third quarter of $4.7 billion, or $2.9 billion after tax, after the company and Morgan Stanley agreed upon a valuation for the Morgan Stanley Smith Barney joint venture, which was formed in June 2009.
Citigroup in June 2009 sold Smith Barney to the joint venture, booking a gain of $11.1 billion, or $6.7 billion after taxes, while retaining a 49% stake in the joint venture. Morgan Stanley had the option of purchasing Citigroup's minority stake in the joint venture over a three year period, beginning this year.
Morgan Stanley in June informed Citigroup that it would purchase an additional 14% stake in the joint venture from Citigroup, after which the companies took over three months to arrive at the joint venture's valuation. The two companies announced that week that Morgan Stanley would buy Citigroup's entire stake, taking another 15% by June 1, 2013, and the remainder by June 1, 2015.
Hawken estimates that Citigroup will report earnings of $3.90 for all of 2012, followed by EPS of $4.75 in 2013.
The analyst said that "Citi's brand is still its biggest asset, especially outside of the United States," and that "we believe the firm will leverage this strength to capitalize on strong demographic and economic trends that exist globally," but that the company "still has a number of major challenges that it faces and is working through."
Looking beyond the 12-month outlook for most sell-side analysts' price targets and recommendations, Hawken said that "Citi is likely a great stock over a longer time horizon," and that "unlocking capital trapped" in the Citi Holdings runoff subsidiary, as well as in the company's deferred tax assets valuation allowance, "could result in strong shareholder returns."
Interested in more on Citigroup? See TheStreet Ratings' report card for this stock.
to a "Neutral" rating from a "Buy" rating, while stocking with his price target of $125.00.
Goldman closed at $119.02 Wednesday, returning 33% year-to-date, following a 46% decline during 2011.
The shares trade for 0.9 times tangible book value, and for 9.5 times the consensus 2013 EPS estimate of $12.50.
Hawken estimates that Goldman Sachs will earn $11.25 a share for all of 2012, followed by EPS of $13.75 in 2013.
The analyst said that "GS navigated the financial crisis with greater agility than most of its peers, and it gained significant market share as it was willing and able to take on risk when clients needed it most."
On the other hand, "the firm has taken a reputational hit more recently and remains in the political crosshairs," according to Hawken, who added that "regulatory overhangs could result in constrained valuation multiple for GS shares until greater certainty emerges around the firm's long-term earnings power."
Interested in more on Goldman Sachs? See TheStreet Ratings' report card for this stock.
to a "Neutral" rating from a "Buy" rating, while maintaining his price target of $19.00.
Morgan Stanley's shares closed at $17.57 Wednesday, returning 17% year-to-date, following last year's 44% decline. The shares trade for 0.6 times their reported June 30 tangible book value of $31.02, and for nine times the consensus 2013 EPS estimate of $1.95.
Hawken estimates that Morgan Stanley will earn a dollar a share for 2012, increasing to earnings of $2.10 a share in 2013.
The analyst said that "MS has made a number of strategic missteps in recent years and has struggled to generate optimal returns for shareholders... as a result, the stock has struggled relative to its peers, and become a 'show me' story."
Once again, the longer-term view is brighter. Hawken said "the firm still has significant brand equity and many of the pieces in place to return the firm to prominence once again."
"While MS is facing several unique threats, its capital and liquidity positions have improved dramatically, and we believe its valuation is attractive even in a relatively severe environment," he said, adding that "the key to a higher multiple for the stock will be to improve the capital efficiency and returns in MS's struggling
trading business and driving
Morgan Stanley Smith Barney margins higher."
Interested in more on Morgan Stanley? See TheStreet Ratings' report card for this stock.
Bank of America
Hawken reiterated his "Neutral" rating for
Bank of America
, while maintaining his price target of $8.00.
Bank of America's shares closed at $9.23 Wednesday, returning 68% year-to-date, after dropping 58% last year. The shares trade for 0.7 times their reported June 30 tangible book value of $13.22, and for 10 times the consensus 2013 EPS estimate of 91 cents.
Bank of America has been pushing to trim noncore assets and gain efficiency through "Project New BAC," with CFO Bruce Thomson saying in July that excluding "legacy assets and servicing," the company's "number of employees has come down from 253,000 to 233,000 or an 8% decline" from a year earlier, as of June 30. Thomson said at a conference on Sept. 10 that after adjusting for goodwill impairment write-downs and annual bonuses paid during the first quarter, "our expenses were down about $3 billion in the second quarter from the prior-year period and down about over $1 billion on a quarter-over-quarter basis."
The Wall Street Journal reported on Wednesday that Bank of America was accelerating its job cuts, with 16,000 layoffs planned before the end of the year.
The focus on expenses cuts and sale of noncore assets has occurred as the company has struggled to work through its legacy burdens of mortgage repurchase demands and outsized loan servicing costs, springing from its purchase of Countrywide Financial in 2008. During the second quarter, Bank of America's mortgage putback claims increased by 41%, to $22.7 billion as of June 30.
Hawken estimates that Bank of America will earn 56 cents a share this year, followed by EPS of 80 cents during 2013.
The analyst said on Wednesday that the "mortgage servicing businesses remain under pressure, as stubbornly high delinquency rates and the requirements of the national mortgage servicing settlement maintain upward pressure on costs," and that "the promise that these costs will moderate has teased equity investors in bank stocks for nearly a year, with the promise of the servicing settlement providing the first hope."
Hawken added that "servicing costs actually increased thanks to the onerous requirements of the settlement, but more worrying, we are concerned that some of these costs will become permanent," as "the business is firmly in the regulators sights, so compliance costs and lengthy processes are unlikely to moderate any time soon."
"Our current estimates reflect a 25% decrease in legacy mortgage servicing costs and litigation in 2013, which we suspect may prove to be too optimistic," he said."
Interested in more on Bank of America? See TheStreet Ratings' report card for this stock.
Hawken reiterated his "Buy" rating for
, while maintaining his price target of $46.00.
JPMorgan's shares closed at $41.26 Wednesday, returning 27% year-to-date, following a 20% decline during 2012. The shares trade for 1.2 times tangible book value, and for eight times the consensus 2013 EPS estimate of $5.20.
The consensus is for JPMorgan to post third-quarter earnings of $1.17 a share. This would be a slight decline from the second quarter, when the company managed to show a profit of $5.0 billion, or $1.21 a share, despite taking a $4.4 billion pre-tax loss from hedge trading activity by its Chief Investment Office.
Hawken estimates that JPMorgan Chase will earn $4.85 a share for all of 2012, followed by EPS of $5.45 in 2013.
The analyst said that "while we are keeping our Buy rating on JPM shares, we believe that stock is vulnerable to the same pressures affecting the group and upside from current levels is likely more limited," adding that "there is likely still a discount being applied to the stock after the CIO trading loss."
"We believe this discount could allow investors to generate excess returns although it may require a longer time horizon," he said.
Interested in more on JPMorgan Chase? See TheStreet Ratings' report card for this stock.
Written by Philip van Doorn in Jupiter, Fla.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.