NEW YORK (
) -- It was a noisy first quarter for banks, filled with complicated accounting and unusual one-time charges that muddied the earnings picture for even the most experience investors. And most analysts agree it will only get harder to understand how U.S. banks really make money.
Special "non-operating items" on bank balance sheets such as debit valuation adjustments (DVA) and credit valuation adjustments (CVA) -- made to reflect the value of outstanding debt and created to give investors a better idea of performance -- have turned into loud distractions.
Guggenheim Securities analyst Marty Mosby says that DVA and CVA accounting is "not useful at all, which is why it is excluded very rapidly" by analysts reviewing quarterly earnings announcements. Mosby adds that "it is unfortunate accounting in my mind, that we try to mark the balance sheet to market so precisely," and that "over time, if a bank has issued a debt a certain rate, it is part of their funding cost. Just because the market has changed, with credit spreads widening or narrowing, doesn't mean that the debt costs already originated and funded are really changing at all."
Beginning in 2007, bank holding companies were able to decide whether or not to use DVA/CVA accounting, and three out of the "big four" U.S. banks chose to do so, with the exception of
, which released a
announcement of record first-quarter earnings release on April 13.
The analyst says that "everyone is getting much more accustomed to these types of moving pieces." For
Bank of America
, for example, "the DVA/CVA number was anticipated, with changes of debt spreads in the market place, so when the number came out, the impact was isolated within minutes."
Mosby says that in the current environment, with plenty of asset dispositions, merger activity, and market turmoil, "you want to make sure you don't react to the reported number too quickly. The first thing we do is sift through the release and try to be a little more patient, because a lot of the moving pieces, once you get them isolated, bring you to the real operating results. You need to do a little diligence when the earnings numbers come out."
For banks benefitting from discount acquisitions in the current distressed environment for financial companies valuations, bottom-line results will be padded with bargain purchase gains or discount accretions, and Mosby says 'you must wade through the impact, as that boils off and determine how much the bank can replace in pricing."
When second quarter results are announced each July, goodwill accounting always comes to the fore, since most banks test the valuation of previous acquisitions, to determine if write-downs are necessary, on an annual basis, during the second quarter. Over the past few years as bank valuations have tanked, there have been very significant second-quarter non-cash goodwill write-downs, which really do nothing but confuse investors.
Mosby says that after the "abnormal significant shift in the value of financial service companies" over the past few years, most of "the goodwill that needed to be written off to reflect the current valuation of financial services companies has already been experienced, and we will get to long-term value stabilizing so we won't have incremental write-downs of goodwill going forward."
The following is a discussion of one-time items affecting five large bank holding companies, starting with the three largest U.S. bank holding companies that all saw their first-quarter GAAP earnings per share skewed by DVA or CVA, as well as various other items:
reported first-quarter net income of $5.4 billion, or $1.31 a share, which included a "$0.9 billion pretax loss ($0.14 per share after-tax reduction in earnings) from debit valuation adjustments," resulting from "tightening of the Firm's credit spreads."
Other one-time items included a $1.1 billion pretax benefit (17 cents a share after-tax) from the Washington Mutual bankruptcy settlement, and $2.5 billion in pretax expenses (39 cent a share after tax) "for additional litigation reserves, predominantly for mortgage-related matters." In addition to the industry-wide recovery in trading revenue during the first quarter, JPMorgan followed the industry trend for strong mortgage banking revenue, and also reported strong credit card sales growth, and very strong and sustained commercial loan growth.
All the items illustrate how difficult it is to gauge earnings from quarter to quarter, but what long-term investors could hang their hat on is a low valuation for the stock to forward earnings estimates, which analysts try very hard to base on true operating performance.
FBR analyst Paul Miller said on April 16 that looking beyond JPMorgan Chase's headline earnings number, "the operating result as relatively in line with expectations given the tailwinds from noninterest income and slow loan growth in what is seasonally the weakest quarter."
Miller said that "Over a long time horizon, we expect the company to record $2.0B to $2.5B of trading revenue per quarter and if we were to normalize the trading line, we would arrive at
a first-quarter operating result closer to $1.25 per share, in line with our expectations for roughly $5.00 in earnings per year. "
The analyst rates JPMorgan Chase "Outperform," with a $50 price target, and estimate the company will earn $5.26 a share this year, followed by 2013 EPs of $5.80.
Despite returning 32% year-to-date through Friday's close at $43.35, JPMorgan's shares were trading for less than eight times the consensus 2013 earnings estimate of $5.60, among analysts polled by Thomson Reuters. JPMorgan is also paying an attractive quarterly dividend of 30 cents, for a dividend yield of 2.77%.
Interested in more on JPMorgan Chase? See TheStreet Ratings' report card for this stock.
Bank of America
Bank of America reported first-quarter net income of $653 million, or three cents a share, however, the results included "negative valuation adjustments of $4.8 billion pretax, or $0.28 per share, from the narrowing of the company's credit spreads."
CFO Bruce Thompson pointed out that "the narrowing of our credit spreads reflects the significant progress we've made to strengthen the balance sheet," and said that the negative adjustment to earnings "should not overshadow the positive momentum that we are seeing in our businesses."
Mosby rates Bank of America a Buy, and said on April 19 after the company announced its first-quarter results that excluding the debit valuation adjustment and an estimated "$2 billion in significant items included in this quarter's earnings," brought "BAC's operating EPS down to $0.15, 3 cents favorable to our estimate of operating earnings per share of $0.12."
The analyst said that "until short-term rates begin to rise, BAC's earnings power is between $10 billion and $12.5 billion a year."
Bank of America's shares closed at $8.25 Friday, returning 49% year-to-date, following a 58% decline during 2011. 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 $1.05. The consensus 2012 EPS estimate is 61 cents.
Mosby rates Bank of America a "Buy," with an $11 price target, and said that "current discount to tangible book value per share represents the potential upside once the market decides that BAC can cover future losses from Countrywide's residential real estate overhang issues with future earnings."
Guggenheim Securities has "calculated a range for potential remaining after-tax losses of $15-40 billion."
Interested in more on Bank of America? See TheStreet Ratings' report card for this stock.
reported first-quarter earnings of $2.9 billion, or 95 cents a share, however, excluding credit and debit valuation adjustments of "a negative $1.3 billion during the first quarter, resulting from the tightening of Citi's credit spreads," and also excluding "a net gain of $477 million from minority investments," Citigroup's operating earnings were $3.4 billion, or $1.11 a share.
Excluding the same items, Citigroup's first-quarter revenue totaled $20.2 billion, increasing 17% sequentially, mainly from the recovery in trading revenue, and 1% year-over-year.
KBW analyst David Konrad rates Citigroup "Market Perform," with a price target of $42, an said on April 16 after Citi reported its earnings that "results were strong as better-than-expected revenues and expense control drove positive operating leverage," and that "although the revenue beat was largely driven by market-sensitive items, we believe this rebound in trading results is key in determining the long-term earnings power of C."
For the rest of the year, Konrad thinks that Citigroup's trading revenue decline from a seasonally-strong first quarter, and also expects "mortgage banking and ongoing levels of reserve release to be modest headwinds on revenues."
Citigroup's shares closed at $33.50 Friday, trading for just two third of their reported March 31 tangible book value of $50.90, and for eight times the consensus 2013 EPS estimate of $4.17, however, Konrad says "the consolidated earnings multiple is not inexpensive at almost 11.3x 2012
estimates, excluding reserve release."
Then again, excluding the results from Citi Holdings -- the repository for the assets being wound down by Citigroup as part of CEO Vikram Pandit's good bank/bad bank strategy to trim noncore assets and shore up capital -- Konrad said that the P/E "multiple drops to below 7.0x."
"Although this metric sets up a good long-term thesis for Citi, "said Konrad," potential softer trading over the summer and delays in capital deployment leave limited catalysts for C over the near term, in our view."
So there you have it. Your decision on whether or not to take the plunge with Citigroup must reflect whether or not you are truly a long-term investor, with a horizon of several years.
Interested in more on Citigroup? See TheStreet Ratings' report card for this stock.
Capital One Financial
reported first-quarter net income available to common shareholders of $1.4 billion, or $2.74 a share, which included a bargain purchase gain of $594 million from the acquisition of ING Direct (USA), as well as "a $160 million benefit related to the company's sale of Visa stock and subsequent reserve adjustments and the absence of approximately $150 million of unique contra-revenue items recorded in the fourth quarter."
Guggenheim Securities analyst Marty Mosby estimated that Capital One's "earnings power rebounded to $1.46" during the first quarter, "as the ING Direct acquisition was accretive, asset quality trends began to improve--further pushing
the loan loss reserve release back up to $190 million--and seasonal factors raised revenues while pulling down marketing expenses."
Mosby expects that "the second quarter should benefit even more, as ING Direct will have been a part of COF for the entire quarter, and approximately $40 billion in excess liquidity will be deployed into the acquisition of the HSBC credit card portfolio," which will include $30 billion in domestic credit card loans.
Mosby rates Capital One a "Buy," with a $67 price target, an estimates the company will earn $5.86 a share during 2012, followed by 2013 EPS of $7.21.
Rochdale Securities analyst Richard Bove on April 20 upgraded his rating on Capital One to a "Buy," with a $65 price target, and estimated that Capital One's "actual operating results for the first quarter may have been $1.64 per share," after excluding all one-time items.
Capital One's closed at $56.06 Friday, returning 33% year-to-date, following a flat return during 2011. The shares trade for 1.4 times their reported March 31 tangible book value of $39.37, and eight times the consensus 2013 earnings estimate of $6.87, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is $6.37.
Interested in more on Capital One? See TheStreet Ratings' report card for this stock.
of Salt Lake City reported first-quarter net income available to common shareholders of $25.5 million, or 14 cents a share.
Excluding "the noncash effects of the discount amortization on conversion of subordinated debt and additional accretion (net of expense) on acquired loans ($15.0 million, $0.08 per share), and the accelerated amortization of discount on the $700 million redemption of Troubled Asset Relief Program ("TARP") preferred stock ($19.6 million, $0.11 per share) in the first quarter," Zions said its net operating earnings were $60.1 million or 33 cents a share.
Zions on March 28 repaid the government $700 million in TARP money, and plans to repay the remaining $700 million during the second half of this year.
Mosby says that for Zions, one-time items from the "conversion of conversion of debt to preferred" stock happens "each quarter, which impacts their income statement and their net interest margin," which "we must always work through."
"There are some debt conversion costs that go in the preferred, so they have some impact on margins and some write down and accretion they took on the debt portion. Every quarter it creates some noise. I think everyone would be happy if they didn't have to deal with it any more.
Mosby has a neutral rating on Zions, and said last Tuesday that the lender's "earnings power has been pressured over the last couple of years due to net interest margin compression and inflated asset quality costs," adding that "ZION may not fully recover from this loss of earnings power until short-term interest rates begin to rise."
Interested in more on Zions Bancorporation? See TheStreet Ratings' report card for this stock.
Written by Philip van Doorn in Jupiter, Fla.
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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.