NEW YORK (TheStreet) -- When bank earnings season kicks off on Tuesday, investors will be "looking back" at a fourth quarter displaying many of the industry's biggest challenges, but some of the pressure is expected to subside during 2014.
A major theme for industry earnings over the past year has been the decline in mortgage refinance activity as long-term interest rates have risen. The Mortgage Bankers Association expects total fourth-quarter originations of one-to-four family residential loans in the United States to decline sharply to $293 billion for the fourth quarter from $401 billion the previous quarter and $597 billion a year earlier.
For many regional banks, analysts' fourth-quarter estimates indicate the mortgage drag will lead to another quarterly earnings decline.
With long-term interest rates expected to continue rising during 2014 in the wake of Federal Reserve's "tapering" of its monthly "QE3" purchases of long-term bonds, the mortgage slowdown is expected to continue, with total originations dropping another 33% this year to $1.174 trillion from an estimated $1.755 trillion in 2013.
The MBA expects a slight rebound in mortgage activity during 2015, but that's a pretty far way off for banks seeing such a major business disruption, so it's a safe bet that big banks will continue cutting mortgage staff. Banks will also see expenses continuing to decline as their inventories of repossessed homes continue to decline and more nonperforming loans are resolved.
Another focus for investors over the next year will be banks' net interests margins. The margin is the spread between the average yield on loans and investments and the average cost for deposits and borrowings. The Federal Deposit Insurance Corp. reported that for the aggregate net interest margin for the entire U.S. banking industry was 3.26%, unchanged from the second quarter but down from 3.43% a year earlier.
Up until the third quarter, banks saw their margins narrowing for several years, mainly because the Fed has kept the short-term federal funds rate in a range of zero to 0.25% since late 2008. The banks saw most of the benefit of the lower cost for deposits several years back, while major portions of their investments and loans continued to reprice at lower rates. A more normal interest rate curve, with the market yield on 10-Year U.S. Treasury bonds close to 3.00%, is helping. But banks quickly sell most of the fixed-rate loans they originate to Fannie Mae and Freddie Mac, meaning they book very little interest from the higher-rate loans. This is a good thing, because even though the long-term rates have risen, they are still very low on a historical basis, and no bank wants to be "stuck" holding a 4.00% mortgage loans, when years later it could be paying a higher rate on savings deposits.
What the banks want to see is a parallel rise in interest rates, which can only come about when the Fed raises the federal funds rate. The Federal Open Market Committee has repeatedly said that barring a rise in inflation, it is unlikely to raise the federal funds rate until the U.S. unemployment rate falls below 6.5%.
We're getting close to that level, since unemployment rate in December declined to 6.7% in December from 7.0% during November. However -- there seems always to be a "however" in any discussion of economics -- the improved unemployment rate was driven in large part by 0.2% decline in the labor participation rate to 62.8%. The labor participation rate declined 0.8% during 2013 -- a large number of people have effectively been driven from the labor force.
So investors will be fixated on the unemployment rate and the federal funds rate this year, just as the market and the media focused on the Fed's tapering plans last year.
For many of the large regional banks, investors will be expecting a continuing theme of strong growth in commercial and industrial loans. These loans are not secured by real estate. Strong C&I growth has been the only real bright spot for may regionals over the past two years, with commercial real estate lending also showing recent gains. Based on the Federal Reserve's lending estimates, KBW analyst Brian Klock in a note to clients on Jan. 5 wrote that C&I lending volume increased at an annual pace of 14.3% during the fourth quarter from 4.2% during the third quarter. Quite a bit of the C&I lending activity is loan renewals, which may not mean an increase in loan balances, however, the renewals are wonderful things, since the loans are likely to reprice higher, and include renewal fees.
Regulator Drag and Valuation
JPMorgan Chase (JPM) - Get JPMorgan Chase & Co. Report entered into $17.5 billion in residential mortgage-backed securities settlements during the fourth quarter with various government authorities, and the company's $2.6 billion settlement with the Department of Justice and bank regulators over its role in the Bernard Madoff Ponzi scheme will also be included in its fourth-quarter financial reports. The RMBS settlements had already been reserved for, but the bank last week said the Madoff settlement would lower fourth-quarter after-tax earnings by about $850 million.
JPMorgan faces more regulatory risk, with ongoing investigations of global banks' LIBOR manipulation by U.S. regulators and multiple investigations at home and abroad of alleged manipulation of foreign exchange trading.
Regulatory angst is reflected in JPMorgan's stock, which trades for just 9.2 times the consensus 2015 earnings estimate of $6.34 a share, among analysts polled by Thomson Reuters, based on Friday's closing price of $58.49. That's the lowest forward price-to-earnings ratio for any large-cap U.S. bank.
Citigroup (C) - Get Citigroup Inc. Report is also cheaply valued on a forward P/E basis, with shares closing at $54.72 Friday and trading for 9.3 times the consensus 2015 EPS estimate of $5.91. At issue is how patient investors may need to be before Citi begins to deploy a major portion of its excess capital through dividends and share buybacks. Nomura analyst Steven Chubak is quite positive about the prospects for Citigroup's stock over the next 12 months, while Jefferies analyst Ken Usdin rates Citi a "hold."
The third-cheapest large-cap U.S. bank stocks on a forward P/E basis is Bank of America (BAC) - Get Bank of America Corp Report, with shares closing at $16.77 Friday and trading for 10.5 times the consensus 2015 EPS estimate of $1.59. That's quite a leap from the consensus EPS estimate of $1.31 for 2014. In fact, it's the largest jump to the consensus 2015 EPS estimates from the consensus 2014 estimate for any large-cap U.S. bank.
The large regional banks trade higher than the nation's three largest banks. The following are brief earnings previews for the five big regional names trading at lowest forward P/E ratios, in descending order:
BBT data by YCharts
Shares of BB&T Corp. (BBT) - Get BB&T Corporation Report of Winston-Salem, N.C., closed at $38.66 Friday. The shares trade for 2.5 times tangible book value, according to Thomson Reuters Bank Insight, and for 11.5 times the consensus 2015 earnings estimate of $3.35 a share. The consensus 2014 EPS estimate is $3.02. Based on a quarterly payout of 23 cents, the shares have a dividend yield of 2.38%.
BB&T is scheduled to announce its four-quarter results on Thursday, with analysts on average estimating earnings of 71 cents a share, up a penny from 70 cents during the third quarter, but matching its EPS during the fourth quarter of 2012.
Citigroup analyst Keith Horowitz in his earnings preview on Jan. 3 wrote, "BBT remains our favorite way to play the regional space," while reiterating his "buy" rating and raising his price target for the shares to $44 from $40.00.
"We still see the most upside in BBT, as its above-average returns and solid management team should justify a premium multiple," Horowitzwrote. BB&Ts return on average tangible equity for the first three quarters of 2013 was a decent 12.21%,, according to Thomson Reuters Bank Insight, however, the third quarter results were lowered by a $235 million tax adjustments. The company's ROTCE has been in the high double digits for three of the past five quarters.
According to Horowitz, BB&T is "well-positioned for a tough environment given its diverse revenue mix and specialized lending business, and the valuation continues to be attractive."
Interested in more on BB&T? See TheStreet Ratings' report card for this stock.
Shares of Regions Financial (RF) - Get Regions Financial Corporation Report of Birmingham, Ala., closed at $10.48 Friday. The shares trade for 1.5 times tangible book value and 11.5 times the consensus 2015 EPS estimate of 91 cents. The consensus 2014 EPS estimate is 84 cents. Based on a quarterly payout of 4 cents, the shares have a dividend yield of 1.15%.
Regions will announce its fourth-quarter results on Jan. 21. The consensus among analysts is for the company to report EPS of of 20 cents, unchanged from the previous quarter, but declining from 21 cents a year earlier.
As part of his fourth-quarter earnings preview, Deutsche Bank analyst Matt O'Connor on Jan. 3 upgraded Regions to a "buy" rating from a "hold" rating, while raising his price target for the stock to $12 from $10.00. "RF is one of the most levered to rising interest rates in general and trades well below similar asset sensitive banks (CMA, KEY and ZION)," on a forward price-to-earnings basis, O'Connor wrote.
O'Connor expects Regions to see a "relatively stable" net interest margin, which rose eight basis points sequentially to 3.24% during the third quarter. He also expects a "more modest" pace of loan growth, following very strong growth in C&I loans during the third quarter, which offset some of the pain from a significant decline in mortgage revenue.
Interested in more on Regions Financial? See TheStreet Ratings' report card for this stock.
Fifth Third Bancorp
Shares of Fifth Third Bancorp (FITB) - Get Fifth Third Bancorp Report of Cincinnati closed at $21.53 Friday. The shares trade for 1.8 times tangible book value and 11.4 times the consensus 2015 EPS estimate of $1.89. The consensus 2014 EPS estimate is $1.75. Based on a quarterly payout of 12 cents, the shares have a dividend yield of 2.23%.
Fifth Third will announce its fourth-quarter results on Jan. 23. Analysts on average estimate fourth-quarter EPS will come in at 42 cents, declining from 47 cents in the second quarter and 43 cents during the fourth quarter of 2012.
The company's third-quarter results had plenty of moving parts, as usual, because of items related to its stake in Vantiv (VNTV) , its former technology subsidiary that was spun-off in 2009. A major negative item for the third quarter was a 48% sequential decline in net mortgage banking revenue to $121 million. But on a more positive note, factoring in share repurchases and leaving out mortgage income, the company showed the greatest year-over-year growth in revenue per share, according to KBW analyst Christopher Mutascio.
Jefferies analyst Ken Usdin in December called Fifth Third his favorite bank stock for 2014, writing in a client note that his $23 price target for the shares assumes the Federal Reserve leaves the federal funds rate unchanged until mid-2015, with potential upside to $27, if the Fed raises the federal funds rate late in 2014.
"After a reset in the origination market in 3Q13, mortgage fees now represent about 6% of total revenues and are approaching a bottom on a quarterly run-rate basis," for Fifth Third, according to Usdin. "We believe this reset and the company's approach to quickly remove costs from the business are important changes for the psychology on the stock," he wrote.
Interested in more on Fifth Third Bancorp? See TheStreet Ratings' report card for this stock.
PNC Financial Services Group
Shares of PNC Financial Services Group (PNC) - Get PNC Financial Services Group, Inc. Report of Pittsburgh closed at $78.77 Friday. The shares trade for 1.6 times tangible book value and 10.6 times the consensus 2015 EPS estimate of $7.45. The consensus 2014 EPS estimate is $6.95. Based on a quarterly payout of 44, the shares have a dividend yield of 2.23%.
PNC will announce its fourth-quarter results on Thursday. Analysts expect EPS of $1.65, down from $1.79 in the third quarter and $1.71 during the fourth quarter of 2012.
Credit Suisse analyst Moshe Orenbuch has a neutral rating on PNC, although he raised his price target for the shares to $85 from $76 on Jan. 8. "We expect operating fee income of $1.6Bn to decline 1% q/q and down 12% y/y with strength in corporate services and asset management to offset a decline in mortgage banking revenues (-19% q/q and -37% y/y)," Orenbuch wrote in his firm's earnings preview for large-cap banks.
On a brighter note, Orenbuch added that PNC's fourth-quarter expenses were likely to remain flat sequentially at $2.4 billion, but down 7% from a year earlier. "PNC reduced mortgage headcount with some benefit in 4Q and full cost savings beginning in 1Q'14 ($24mm annual savings). Looking ahead, mgmt is reviewing redundancies and integration expenses and revamping in order to bring down operational expenses," he wrote.
Interested in more on PNC Financial Services? See TheStreet Ratings' report card for this stock.
Capital One Financial
Shares of Capital One (COF) - Get Capital One Financial Corporation Report of McLean, Va., closed at $78.02 Friday. The shares trade for 1.8 times tangible book value and 10.6 times the consensus 2015 EPS estimate of $7.39. The consensus 2014 EPS estimate is $6.95. Based on a quarterly payout of 30 cents, the shares have a dividend yield of 1.54%.
Capital One is of course best-known as one of the nation's largest credit card lenders, but the bank also has an extensive branch network on the east coast. The bank also gathers deposits through the Internet, following its 2012 acquisition of ING Direct (USA).
The company will announce its fourth-quarter results after the market close on Thursday. Analysts expect the company to report EPS of $1.55, down from $1.86 in the third quarter, but up from $1.42 during the fourth quarter of 2012.
Following the disruption during 2012 from the company's acquisitions of ING Direct (USA) and HSBC's U.S. credit card portfolio, investors have been relieved to see Capital One report three solid quarters during 2013. The company's return on average tangible common equity for the first three quarters was 17.02%. Investors expect more, considering Capital One's fat net interest margin of 6.89% during the third quarter, reflecting the credit card focus.
The company this year sold its $6 billion private label card portfolio to Citigroup, and its average domestic card loans were down 13% year-over-year to $69.9 billion in the third quarter.
While December numbers won't be available until Wednesday, Capital One reported last month that its average domestic credit card loans held for investment grew to $69.7 billion in November from $69.5 Billion in October. The November number is a slight decline from September, but it's possible the company has turned the corner to resume growing its card portfolio.
FBR analyst Paul Miller last month raised his price target for Capital One to $85 from $82, while maintaining his "outperform" rating. "We expect that the combination of the resumption of receivables growth in 2H14 as the targeted runoff of HSBC acquisition-related receivables is completed, increased return of capital via share repurchase, and the ability to reduce expenses will drive a higher valuation," Miller wrote in a client note.
Interested in more on Capital One? See TheStreet Ratings' report card for this stock.
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-- 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.