Updated from 7:10 a.m. ET with comment on Everbank from Sterne Agee analyst Peyton Green.
NEW YORK (
) -- The stock market rally -- led by the financial sector -- can't go on forever, so long-term investors need to dig a bit further to find value.
A few years ago, when banks had clearly turned the corner from the credit crisis, it was fairly easy for investors to identify strengthening banks trading for less than tangible book value and at rather low multiples to forward earnings estimates. With the
KBW Bank Index
rising 31% this year through Friday, which followed a 30% rally during 2012, things appear to be getting a little "hot."
Based on second-quarter results, the earnings improvement for banks has decelerated. Rafferty Capital Markets analyst Richard Bove, in a note to clients on July 25, wrote that for "the vast majority" of banks with total assets in excess of $25 billion "there was no improvement in core earnings but a significant improvement in reported earnings" for the second quarter.
"The psychology today is that banks can do no wrong and the stocks are being aggressively purchased," Bove wrote. He added that "these stocks are still cheap," and that they "should be bought," but he also said investors need to "look for those that have shown core earnings growth."
Bove also warned that "at this moment, it appears that any bank stock will do as long as it has the name 'bank' in it. That is dangerous investing."
Most banks have continued a rather depressing focus on cost-control, during an extended period of generally weak demand for favored loan types and narrowing interest margins (NIM), as the
has kept the short-term federal funds rate in a range of zero to 0.25% since the end of 2008. The Federal Open Market Committee has repeatedly stressed that this "highly accommodative" monetary stimulus policy will likely remain appropriate at least until the U.S. unemployment rate drops below 6.5%. On Friday, the Bureau of Labor Statistics said the unemployment rate during July improved to 7.4% from 7.6% in June, so it would appear the banks will be kept waiting quite some time for the parallel rise in rates that will be brought about when the federal funds rate is finally raised.
Taking It Out to 2016
KBW analyst Christopher Mutascio last week looked ahead three years to estimate "normalized" earnings for large-cap banks in a more favorable interest rate environment. The analyst considered two scenarios for large-cap banks' net interest margins. The first scenario assumed no margin expansion from second-quarter levels, through 2016. The second scenario was termed "most optimistic, with substantial NIM expansion," while the third scenario generally assumed "the midpoint between the current and 20-year median NIMs."
Based on 2016 earnings estimates under the third scenario, Mutascio concluded that
Bank of America
among companies covered by KBW.
Bank of America shares closed at $14.85 Friday and traded for 8.0 times Mutascio's earnings estimate of $1.85 a share for 2016. JPMorgan closed at $56.49 Friday, or 9.0 times Mutascio's 2016 EPS estimate of $6.30 under the third scenario.
For long-term investors who can make a commitment for at least three years, Bank of America and JPMorgan Chase have certain "advantages" that can create opportunities.
Some investors are shying away from Bank of America because the company seems likely over the next year or two to book additional extraordinary charges, as it settles mortgage repurchase claims with institutional investors. The bank restated its first-quarter results to reflect a $1.6 billion charge tied to its mortgage putback settlement with bond insurer
, lowering Bank of America's first-quarter earnings by $1.1 billion, or 10 cents a share, to $1.5 billion, or 10 cents a share.
Bank of America reported unresolved mortgage repurchase claims against the company for loans originated between 2004 and 2008, of $16.648 billion as of June 30.
Some investors are steering clear of JPMorgan Chase too, despite the company's strong profitability because of continued headline risk from multiple regulatory investigations and the still uncertain political environment for the biggest banks. JPMorgan last week
to settle charges of energy market manipulation by the Federal Energy Regulatory Commission. The company had previously announced it was considering "strategic alternatives" for its physical commodities business.
How About Focusing on Quality?
For long-term investors looking for quality picks among smaller, rapidly growing regional banks, two names that keep cropping up are
First Republic Bank
of San Francisco and
of New York.
First Republic's shares closed at $44.35 Friday and traded for 14.1 times the consensus 2014 earnings estimate of $3.14 a share, among analysts polled by Thomson Reuters. The consensus 2015 EPS estimate is $3.39. The bank on July 17 reported second-quarter earnings of $113.7 million, or 77 cents a share, increasing from $97.9 million, or 60 cents a share, during the second quarter of 2012. The bank said "excluding the impact of purchase accounting, core net income was $97.1 million, up 37% from last year." First Republic had $30.7 billion in loans as of June 30, growing 20% from a year earlier.
FBR analyst Paul Miller rates First Republic "outperform," with a $48 price target. In a note to clients following the earnings announcement, Miller wrote "based on the company's existing meaningful excess capital and cross-selling capabilities," he expects the jumbo mortgage specialist "to execute its growth strategy successfully in the coming quarters."
Signature Bank's shares closed at $93.70 and traded for 18.4 times the consensus 2014 EPS estimate of $5.09. The consensus 2015 EPS estimate is $5.76. The bank reported second-quarter earnings of $53.6 million, or $1.12 a share, increasing from $45.3 million, or 96 cents a share, a year earlier. The bank's net portfolio loans grew 13% year-over-year, to $10.9 billion as of June 30.
Oppenheimer analyst Terry McEvoy rates Signature Bank "outperform" with a 12-18 month price target of $100, and in a note to clients on July 23 wrote, "Signature's operating model continues to gain momentum in the New York market place with four new banking teams hired and ~$700M of loan growth in the most recent quarter. The move up in
long-term rates is a positive to future securities yields and commercial real estate loan pricing has improved implying a more favorable outlook for Signature's net interest margin." The analyst expects earnings growth of 12% next year for Signature Bank.
But a focus on quality names with strong loan growth may not necessarily lead to the strongest returns. After all, Bank of America's shares have returned 28% this year through Friday, after more than doubling last year.
Cheapest Forward P/E
For long-term investors looking for the cheapest bank stocks relative to forward earnings estimates, regardless of any other factor, we have identified five names trading at lowest valuations to consensus 2015 earnings estimates, using data supplied by Thomson Reuters Bank Insight. We did not take our analysis out to 2016, as KBW did, because 2016 estimates are not available for the great majority of bank stocks.
Our "stick to the wall" approach limited us to the 105 stocks among 1,101 publicly traded U.S. banks for which consensus 2015 EPS estimate data was available. JPMorgan Chase and Bank of America made our initial "cheapest five" list. JPMorgan was the second-cheapest at Friday's close, with shares trading for 8.8 times the consensus 2015 EPS estimate of $6.43. Bank of America was third, with shares trading for 9.2 times the consensus 2015 EPS estimate of $1.61.
Leaving aside Bank of America and JPMorgan, here are the five U.S. bank stocks trading at lowest valuations to consensus 2015 earnings estimates:
5. Everbank Financial
of Jacksonville, Fla., closed at $15.66 Friday, returning 5% this year. The shares trade for 10.0 times the consensus 2015 earnings estimate of $1.56 a share. The 2014 EPS estimate is $1.46. The company went public on May 3, 2012, at an opening share price of $10.
Everbank has built upon its national mortgage banking platform through the acquisition of
Capital's business property lending unit and
mortgage warehouse business.
The company reported second-quarter net income allocated to common shareholders of $43.5 million, or 35 cents a share, increasing from $9.5 million, or 9 cents a share, a year earlier. The swing in earnings year over year mainly reflected $64.3 million in amortization and impairment charges for mortgage servicing rights during the second quarter of 2012.
Everbank also reported adjusted earnings, to net out impairment charges and recoveries on mortgage servicing rights, as well as non-recurring regulatory related expenses. Adjusted earnings allocated to common shareholders were $34.8 million, or 28 cents a share, during the second quarter, compared to $41.2 million, or 33 cents a share, in the first quarter, and $34.3 million, or 33 cents a share, during the first quarter of 2012. The year-over-year decline in EPS reflected the May 2012 common-share offering, as well as smaller share-count increases in succeeding quarters.
Everbank's second-quarter return on average assets (ROA) was 1.00% and its return on average tangible common equity (ROTCE) was 13.67%, according to Thomson Reuters Banking insight.
CEO Robert Clements, in the company's earnings release on July 30, said, "We remain confident in our ability to generate earnings growth and attractive risk-adjusted returns over the long term." Everbank's second-quarter revenue totaled $288 million, increasing 4% sequentially and 45% year over year.
Sterne Agee analyst Peyton Green rates Everbank a "buy," with a price target of $18, and in a note on July 31 wrote "we believe that management will continue to shift the business mix to higher valuation lines over the next six quarters."
"EVER will exit the wholesale
mortgage broker channel (~17% of volume in 2Q13; 65% refi) in order to focus on retail, consumer direct, and correspondent," according to Green.
"Tactically, EVER sold ~$1B of loans HFS ($2B at 2Q13-end), or all of its fixed-rate jumbos, subsequent to quarter end. Going forward, EVER's concentration in jumbo ($1.1B; +50% LQ), shift toward hybrid ARMs (~$500 million in 2Q13), and retail ($1.2B; +50% LQ; 50% purchase) should keep volumes in good shape."
Green argued that the bank's concentration in jumbo mortgage lending, with shift toward hybrid adjustable-rate loans and retail distribution, "should keep volumes in good shape."
The analyst estimates Everbank will earn $1.35 a share this year, with EPS increasing to $1.45 in 2014 and $1.55 in 2015.
Interested in more on Everbank Financial? See TheStreet Ratings' report card for this stock.
4. Discover Financial Services
Discover Financial Services
closed at $51.13 Friday, returning 33% this year, following a 63% return during 2012. The shares trade for 9.8 times the consensus 2015 EPS estimate of $5.21. The consensus 2014 EPS estimate is $4.96.
Discover has been one of the strongest performers among U.S. bank holding companies for several years. The company's second-quarter return on tangible common equity was 25.58%, following ROTCE of 26.82% in 2012 and 28.55% during 2011.
Several major credit card lenders have been reporting declines in total outstanding credit card loan balances, as U.S. consumers continue to deleverage. Discover has bucked this trend. The company's average loans grew 7% year over year to $60.8 billion during the second quarter, with 5% growth in credit card loan balances, 5% growth in private student loans to $7.9 billion, and 21% in personal loans to $3.5 billion.
Oppenheimer analyst Ben Chittenden rates Discover "outperform," with a 12-18 month price target of $57, and in a note clients on July 24 wrote that the company's second-quarter net interest margin of 9.44%, rising from 9.39% the previous quarter, and its loan growth "bettered expectations."
The credit card loan losses are at cyclical lows and still improving for Discover. "This combination of better loan growth and continued lower than anticipated credit costs drives much of the reason we think Street expectations will move higher over time and why we think the stock will outperform," the analyst wrote.
Interested in more on Discover Financial Services? See TheStreet Ratings' report card for this stock.
3. Capital One Financial
closed at $69.59 Friday, returning 21% this year, following a 36% return during 2012. The shares trade for 9.5 times the consensus 2015 EPS estimate of $7.31. The consensus 2014 EPS estimate is $6.80.
for details on Capital One's second-quarter results, which were described on July 18 as "pleasantly solid" by KBW analyst Sanjay Sakhrani.
Sakhrani rates Capital One "outperform," with a price target of $79, and in a note to clients wrote that the company's "U.S. Card revenue margin was better than our estimates and appears to be sustainable."
"COF remains well-capitalized and is in a position to substantially raise its payout ratio in 2014." The company pays a quarterly dividend of 30 cents on common shares, for a dividend yield of 1.72%. Capital One didn't request Federal Reserve approval for share repurchases through the first quarter of 2014, because of its 2012 acquisitions of ING Direct (USA) and the
U.S. credit card portfolio.
Interested in more on Capital One Financial? See TheStreet Ratings' report card for this stock.
, of Hato Rey, Puerto Rico, closed at $33.31 Friday, returning a 60% this year, following a 50% return during 2012. The shares trade for 9.3 times the consensus 2015 EPS estimate of 3.57. The consensus 2014 EPS estimate is $3.12.
Popular owes $935 million to the U.S. Treasury for bailout assistance received in December 2008 through the Troubled Assets Relief Program, or TARP.
The company reported second-quarter net income applicable to common stock of $326.5 million, or $3.18 a share, increasing from $64.8 million, or 63 cents a share, a year earlier. The second quarter featured significant one-time items, including an after-tax gain of $156.6 million from the initial public offering in April of its former transaction processing subsidiary
. After selling a portion of its Evertec shares, Popular had a 33.5% stake in the former subsidiary as of June 30.
Popular also sold about $435 million in nonperforming mortgage loans during the second quarter, booking an after-tax loss of $107.1 million.
Excluding the gains on the Evertec IPO and sale of shares, accounting adjustments from the discontinuation "the elimination of its proportionate ownership share of intercompany transactions with EVERTEC from their respective revenue and expense categories," and the "impact of the Puerto Rico tax reform, Popular said its adjusted second-quarter earnings came to $68.1 million.
Popular has been working for several years to move beyond the severe and extended recession in Puerto Rico. The company said that as of June 30, nonperforming loans made up 2.85% of its total loans held in portfolio, reaching "their lowest level since 2006."
KBW analyst Brian Klock rates Popular "outperform," with a price target of $36, and in a note to clients on July 18 wrote, "We believe core earnings power and fundamentals continue to improve and while provisions
for loan losses were higher this quarter, we expect more credit leverage in the quarters to come to help drive bottom-line growth."
"BPOP remains one of the few larger regional banks with strong capital levels, solid
pre-tax, pre-provision ROA levels (with levers to improve ROA) and credit leverage," according to Klock. "Plus, we believe BPOP is well-positioned to exit TARP within the next 2-4 quarters without a common raise."
Popular is quite a recovery story, and the bank hasn't finished traveling its path to solid profitability, meaning there could be plenty of upside heading into the TARP repayment.
Interested in more on Popular, Inc.? See TheStreet Ratings' report card for this stock.
trades at a lower valuation than any other U.S bank to its consensus 2015 earnings estimate. The shares closed at $53 Friday, returning 34% this year, following a 51% return during 2012. Citi trades for 8.6 times the 2015 EPS estimate of $6.15. The consensus 2014 EPS estimate is $5.57.
It isn't a surprise to see Citigroup at the top of this list, considering the drag on stock valuations for "too big to fail" banks, in the continually uncertain political and regulatory environment. But there's no denying that the company has made quite a bit of progress in its strategy of selling off or winding down non-core assets, in order to boost its capital strength and trim expenses.
Citigroup on July 15 reported second-quarter earnings of $4.2 billion, or $1.34 a share, increasing from $3.8 billion, or $1.23 a share, in the first quarter, and $2.9 billion, or 95 cents a share, during the second quarter of 2012.
Excluding credit valuation adjustments (CVA) and debit valuation adjustments (DVA), earnings were $3.9 billion, or $1.25 a share, declining from $4.0 billion, or $1.29 a share the previous quarter. Operating earnings were up 25% from $3.1 billion, or $1.00 a share, during the second quarter of 2012, excluding CVA/DVA and also excluding a loss during the second quarter of 2012 tied to the sale of the company's stake in Akbank.
Again excluding CVA/DVA, Citi's total second-quarter revenue was $20.0 billion, up 8% year-over-year.
Atlantic Equities analyst Richard Staite in a note following the earnings release wrote, "The results compared favorably against JPM with
tangible book value per share increasing by 1.4% to $53.10 and the Basel III ratio improving to 10.0%," following the Federal Reserve's announcement of its final capital rules.
Citigroup's estimated Basel III Tier 1 common equity ratio of 10.0% puts the company in full compliance with the Federal Reserve's minimum requirement of 7.0% plus an additional 2.5% buffer as a global systemically important financial institution (GSIFI), years ahead of the January 9.5% several years ahead of the January 2019 due date.
Citigroup also estimated that its Basel III supplementary Tier 1 leverage ratio was 4.9% as of June 30, putting it close to full compliance with federal regulators' new minimum requirement of 5% for holding companies, ahead of a January 2018 deadline. Citi estimated its main banking subsidiary was already in compliance with a 6% Basel III supplementary Tier 1 leverage ratio minimum requirement.
When comparing Citi's results against JPMorgan Chase's results, Staite emphasized a second-quarter net interest margin of 2.82%, which was down from 2.95% the previous quarter. JPMorgan's second-quarter net interest margin was 2.20%, falling from 2.37% the previous quarter.
Continuing the comparisons with JPMorgan, Staite pointed out that Citi's banking and securities revenues were up 21% year-over-year, even better than a solid 16% increase for JPMorgan.
Staite rates Citigroup "overweight" with a price target of $59.
Interested in more on Citigroup? 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.