NEW YORK (
) -- With regional banks facing great difficulty growing their earnings in the current low-rate environment, Goldman Sachs analyst Richard Ramsden favors three of the "big four" U.S. banks for investors.
Now that most of the large-cap banks have reported their third-quarter results, the trends include strong mortgage volume from the wave of refinancing, credit quality improvement with a recovery in housing values that becomes more clear with each economic report and, "better than expected capital markets revenue," according to Ramsden, who also said that there was another "reason for optimism in the pace of capital accretion" heading into the next round of
But Ramsden also said that the third-quarter results have "highlighted the biggest risk to bank earnings power: rapidly declining net interest margins." With the Federal Reserve keeping its target federal funds rate in a range of zero to 0.25% since the end of 2008, most banks have already seen most of the benefit in lower interest expense, while long-term rates have continued to decline. The Fed in September increased its
of long-term mortgage-backed securities by $40 billion in an effort to hold long-term rates down.
telegraphed the margin pressure, when Tim Sloan said at a conference last month that the bank's net interest margin -- the difference between the average yield on loans and investments and the average cost for deposits and borrowings -- for the third quarter "could be similar to what we experienced in the third quarter of last year when our net interest margin was down 17 basis points."
ended up at 3.66%, narrowing by 25 basis points from 3.91% the previous quarter, and 3.84%, a year earlier.
Among regional banks,
of Winston-Salem, N.C., saw its
net interest margin held up nicely at 3.94%, declining only one basis point from the second quarter, however, the shares declined 8% over last Thursday and Friday, after the company estimated that its margin would "be in the mid-3.70s% range in 4Q12," because of lower rates being earned on new assets, higher long-term debit cost, and the runoff of assets covered by the Federal Deposit Insurance Corp. loss-sharing agreement, covering nonperforming assets acquired when BB&T purchased the failed Colonial Bank of Montgomery, Ala., in 2009.
of Dallas last Wednesday reported
of $116 million, or 61 cents a share, missing the consensus estimate of a 65-cent profit, among analysts polled by Thomson Reuters. While the earnings miss was driven by a $14 million decline in noninterest income and $16 million increase in noninterest expense from the second quarter, Comerica's net interest income declined to $427 million, from $435 million the previous quarter, as the company's net interest margin narrowed by 14 basis points sequentially to 2.96%.
FBR analyst Paul Miller -- who rates Comerica "Market Perform," with a $34 price target -- on Monday said that "given its asset sensitivity and leverage to floating rate
commercial and industrial lending, Comerica will likely struggle to grow earnings in the current rate environment."
Ramsden on Monday said that "the rate of asset yield pressure is worse than expected and funding benefits are only finite. Our revised estimates imply that with 18bp of NIM pressure through 4Q13, banks face an 11% EPS headwind (all else equal)," and because "all banks will be negatively impacted, we prefer large-cap banks with other levers for EPS growth."
"Given acute NIM pressure and only modest asset growth opportunities," Ramsden said "we favor large-cap banks given 1) less reliance on spread income, and 2) greater offsets from expense / capital leverage," and that he "continued to favor
" JPMorgan Chase
and Wells Fargo, and that although
Bank of America
"meet the EPS leverage requirements, valuation appears reflective, in our view."
Considering the company's lingering material and headline risk from mortgage putback demands, springing mainly from its disastrous purchase of Countrywide Financial in 2008, it may be a surprise to see Bank of America's shares as "expensive," to forward earnings, but the shares trade at the highest forward P/E among the big four U.S. banks.
Bank of America's shares closed at $9.55 Monday, returning 72% year-to-date, following a 58% decline during 2011. In one respect, the shares remain heavily discounted, trading for just 0.7 times their reported Sept. 30 tangible book value of $13.48, but the shares are relatively expensive, at 10 times the consensus earnings estimate of 95 cents a share, among analysts polled by Thomson Reuters.
Bank of America reported a small
of $340 million, or zero cents per share, with earnings hit by $1.6 billion in litigation expenses, from the company's settlement of a class action lawsuit related to its acquisition of Merrill Lynch in 2009.
Ramsden has a neutral rating on Bank of America, with a $10 price target, estimating the company will earn 95 cents a share in 2013 and $1.20 a share in 2014.
Here's a quick look at the remaining members of the big four banking club that Ramsden recommends, ranked by ascending upside based on the analyst's price targets:
Shares of Citigroup closed at $37.72 Monday, returning 44% year-to-date, following a 44% decline during 2011.
The shares trade for 0.7 times their reported tangible book value of $52.70, and for eight times the consensus 2013 EPS estimate of $5.30.
Of course, the biggest recent news for Citigroup is a change at the top, with CEO
resigning last Tuesday, being quickly replaced by Michael Corbat who had previously serviced as the company's CEO of Europe, the Middle East and Africa.
Corbat also previously headed Citi Holdings, which is the subsidiary holding Citigroup's noncore assets, as they run down, in keeping with Pandit's long-term "good bank/bad bank" strategy to right-size the company's balance sheet and free up capital.
Pandit's exit was quite a surprise, coming just one day after Citi announced what most analysts thought was a
, with earnings of $468 million, or 15 cents a share, declining from 95 cents during the second quarter, and $1.23 during the third quarter of 2012.
Citi's third quarter featured several one-time items, including a $4.7 billion pre-tax loss on the company's sale of a 14% stake in the Morgan Stanley Smith Barney joint venture, and the write-down of its remaining stake in the joint venture, as well as a negative $776 million in debit valuation adjustments, and a $582 million tax benefit. Excluding these items, the company earned $3.3 billion, or $1.06 a share.
Citigroup's net interest margin for the third quarter was 2.84%, expanding from 2.76% the previous quarter, but narrowing from 2.95% a year earlier.
The company's estimated Basel III Tier 1 common equity ratio was 8.6% as of Sept. 30, increasing from 7.9% in June, as Citi Holdings continued to wind down.
Following Corbat's appointment as Pandit's successor, Citigroup Chairman Mike O'Neill hinted that the company's balance sheet reduction -- which should eventually free up enough capital for a significant return to investors though dividend increases and share buybacks -- might accelerated, as the company's board of directors believed "he will place a special emphasis on sharpening the Company's focus on achieving sustained, strong, operating performance." O'Neill also pointed out that Corbat "was the CEO of Citi holdings from its inception, where he managed the wind down of nearly $600 billion of non-core assets."
Ramsden's price target for Citigroup's shares is $42, and he estimates the company will earn $4.75 a share in 2013 and $5.25 in 2014.
Interested in more on Citigroup? See TheStreet Ratings' report card for this stock.
2. Wells Fargo
Shares of Wells Fargo closed at $34.50 Monday, returning 27% year-to-date, following 10% decline during 2011.
The shares trade for 1.5 times tangible book value, according to Thomson Reuters Bank Insight, and for 9.5 times the consensus 2013 EPS estimate of $3.63. Based on a quarterly payout of 22 cents, the shares have a dividend yield of 2.55%.
Wells Fargo reported third-quarter earnings applicable to common stock of $4.7 billion, or 88 cents a share, increasing from $4.4 billion, or 82 cents a share, in the second quarter, and $3.8 billion, or 72 cents a share, during the third quarter of 2011.
The company's third-quarter net interest margin declined by 25 basis points sequentially to 3.66%, its third-quarter net interest income totaled $10.7 billion, declining sharply from $11.0 billion the previous quarter, while increasing from $10.5 billion a year earlier. Wells Fargo CFO said during the company's earnings conference call that "we expect continued pressure on the net interest margin given this low rate environment... however, we don't believe the net interest margin decline we had this quarter is representative of what we will see in the future."
Wells Fargo's noninterest income increased to $10.6 billion in the third quarter, from $10.3 billion in the second quarter, and $9.1 billion in the third quarter of 2011. Mortgage banking revenue totaled $2.8 billion, declining from $2.9 billion the previous quarter, but increasing from $1.8 billion a year earlier. During the third quarter, the company reported $529 million in net gains from trading activities, increasing from $263 million the previous quarter, and from losses of $442 million in September of last year.
Ramsden said that Wells Fargo's mortgage production volume was up 6% sequentially and 56% year-over-year, and that "volume during the first few weeks of October has accelerated as rates reached new lows." The analyst expects the high refinance volume "to continue on for a few quarters."
Another bright spot for Wells Fargo in the third quarter was trust and investment fees, which grew to $3.0 billion, from $2.9 billion the previous quarter, and $2.8 billion a year earlier.
Like most of the large banks, Wells Fargo has been focused on reducing expenses. Total noninterest expense declined to $12.1 billion in the third quarter from $12.4 billion in the second quarter, although expenses were up from $11.7 billion in the third quarter of 2011, with rising costs for employee compensation and benefits.
With so many moving parts, the efficiency ratio is a useful measure of the company's expense control efforts. The efficiency ratio is, essentially, the number of pennies of overhead expenses for each dollar of revenue. Wells Fargo's efficiency ratio improved to 57.1 in the third quarter, from 58.2 the previous quarter, and 59.5 a year earlier.
The company has had the strongest and most consistent earnings performance among the big four, with a return on average assets (ROA) of 1.34% over the past 12 months ended Sept. 30, and a return on average tangible common equity (ROE) of 15.86%, according to Thomson Reuters Bank Insight.
Ramsden's price target for Wells Fargo is $40, and he estimates the company will earn $3.65 a share in 2013, followed by EPS of $3.95 in 2014.
Interested in more on Wells Fargo? See TheStreet Ratings' report card for this stock.
1. JPMorgan Chase
Shares of JPMorgan Chase closed at $42.09, returning 30% year-to-date, following a 20% decline during 2011.
The shares trade for 1.2 times tangible book value, and for eight times the consensus 2013 EPS estimate of $5.30. Based on a quarterly payout of 30 cents, the shares have a dividend yield of 2.85%.
JPMorgan reported third-quarter earnings of $5.7 billion, or $1.40 a share, increasing from earnings of 5.0 billion, or $1.21 a share, during the second quarter, when the company booked $4.4 billion in hedge trading losses. In Sept. 2011, the company earned $4.3 billion, or $1.02 a share.
The company suspended its share buyback program in May, after CEO James Dimon first announced the hedge trading losses. During the third-quarter earnings conference call, Dimon the company might resume share repurchases in the first quarter, but said buybacks before the next round of Federal Reserve stress tests would be "immaterial."
Dimon also said during the call that "the Firm reported strong performance across all our businesses in the third quarter of 2012. Revenue for the quarter was $25.9 billion, up 6% compared with the prior year, or 16% before the impact of
debit valuation adjustments."
Dimon added that "business Banking loan balances grew for the eighth consecutive quarter to a record $19 billion, up 8% compared with the prior year," while "Mortgage Banking originations were $47 billion, up 29% compared with the prior year," credit card sales volume increased by 11% year-over-year, and "Commercial Banking reported record revenue and grew loan balances for the ninth consecutive quarter to a record $124 billion, up 15% compared with the prior year." Commercial Banking loans grew 3% from the previous quarter.
Total loans declined 1% sequentially but grew 4% year-over-year, to $721.9 billion, as of Sept. 30.
Noninterest revenue grew28% sequentially and 19% year-over-year, to $14.2 billion in the third quarter, with $2.0 billion in revenue from principal transactions, growing from $427 million in losses the previous quarter, and revenue of $1.4 billion a year earlier. Third-quarter mortgage banking and related income totaled $2.4 billion, increasing from $2.3 billion in the second quarter, and $1.4 billion in the third quarter of 2011.
JPMorgan reported third-quarter net interest income of $11.0 billion declining from $11.1 billion the previous quarter and $11.8 billion a year earlier, as the company's core net yield on interest-earning assets narrowed to 2.92% during the third quarter, from 3.00% during the second quarter, and 3.14% during the third quarter of 2011.
For the 12-month period ended Sept. 30, the company's ROA has been 0.84% and its ROE has been 13.32%, according to Thomson Reuters Bank Insight.
Ramsden's price target for JPMorgan Chase is $50. The analyst estimates the company will earn $5.35 a share in 2013, followed by 2014 EPS of $5.70.
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.