Capital One: Financial Winner (Update 1)

Updated with Wells Fargo's after-market announcement about the mortgage foreclosure settlement with the Federal Reserve and the Office of the Comptroller of the Currency.

NEW YORK ( TheStreet) -- Capital One ( COF) was winner among the largest U.S. banks on a generally weak Monday for the financial sector, with shares rising 1.5% to close at $62.88.

The broad indexes all saw slight declines, and the KBW Bank Index ( I:BKX) was also down slightly, closing at 53.55, with all but seven of the 24 index components down for the session.

Bank of America's Kitchen-Sink Fourth Quarter


Bank of America ( BAC) led off a big day for the banking industry, announcing the end of its year-long battle with Fannie Mae ( FNMA), agreeing to pay the government-sponsored mortgage giant $3.6 billion in cash and also repurchase $6.75 billion in mortgage loans that it (or Countrywide Financial, acquired by BAC in 2008) had originated and sold to Fannie before 2008. Bank of America said that the Fannie Mae settlement would be covered by its existing reserves, plus "an additional $2.5 billion (pretax) in representations and warranties provision recorded in the fourth quarter of 2012."

Bank of America said that the Fannie Mae settlement would lower its fourth-quarter earnings by $2.7 billion, but the company wasn't through announcing one-time items for the quarter. The company said that the fourth-quarter results would also be "negatively impacted by approximately $2.5 billion (pretax) for the independent foreclosure reviews, litigation (primarily mortgage-related), and other mortgage-related matters."

Bank of America also announced that Fannie Mae, Freddie Mac ( FMCC) and Ginnie Mae had approved its plan to sell servicing rights on 2 million residential mortgage loans, with unpaid balances totaling $306 billion. About 232,000 of the loans for which servicing rights will be transferred are past due 60 days or more.

The transfer of mortgage servicing rights will "occur in stages over the course of 2013," and Bank of America expects the transfers to "have a benefit over the book value of the mortgage servicing rights of approximately $650 million," with about one half of the benefit being booked in the fourth quarter.

The company said that it expects "earnings per share to be modestly positive for the fourth-quarter of 2012," factoring-in a $1.3 billion tax benefit from the recognition of foreign tax credits and "approximately $700 million of pretax negative debit valuation adjustments (DVA) and fair value option (FVO) adjustments related to the continued improvement in the company's credit spreads."

Walter Investment Management ( WAC) on Monday announced that it had agreed to acquire servicing rights for about 650,000 loans with unpaid balances totaling $93 billion from Bank of America for $519 million, with the transfers taking place during the first and second quarters.

Also on Monday, Nationstar Mortgage ( NSM) announced an agreement to buy servicing rights for 1.3 million mortgage loans with unpaid balances totaling $215 billion, for $1.3 billion.

Bank of America's shares were down two cents to close at $12.09. The shares are now up 4% year-to-date. The shares returned 110% during 2012, recovering partially from their 58% swoon during 2011. The shares are still down 8% from the end of 2011.

The shares trade for 0.9 times their reported Sept. 30 tangible book value of $13.48, and for 12.5 times the consensus 2013 earnings estimate of 97 cents a share, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is $1.25.

Stifel Nicolaus analyst Christopher Mutascio rates Bank of America a "Buy," with a $13 price target, and in a note on Monday said that he expected the expense reduction from the sale of mortgage servicing rights (MSR) and the "lower future representation and warranty costs" from the Fannie Mae settlement "to result in a pull-forward of normalized earnings for the company."

Mutascio said that his price target for the shares represents a price-to-forward-earnings "multiple of 11.0x our 2014 EPS estimate of $1.20. While this may seem a bit rich, it represents just 8.5x what we believe is BAC's normalized earnings power of roughly $1.50 per share. Further, our target price represents just 83% of our year-end 2014 tangible book value per share estimate of $15.68."

More Cash for Foreclosure Foul-Ups


The Independent Foreclosure Review was part of a previous mortgage foreclosure settlement between Bank of America and other large mortgage servicers, including Citigroup ( C), JPMorgan Chase ( JPM), Wells Fargo ( WFC), U.S. Bancorp ( USB), PNC Financial Services Group ( PNC) and SunTrust ( STI), with the Federal Reserve and the Office of the Comptroller of the Currency. The two regulators on Monday announced that the foreclosure review had ended with the servicers subject to the foreclosure settlement agreeing make $8.5 billion in cash payments and other assistance to borrowers victimized by servicing errors. Borrowers could receive up to $125,000 each.

Citigroup said in a statement that it expected "to record a pre-tax charge of approximately $305 million in the fourth quarter of 2012 for its cash payment portion of the settlement," and that its "approximately $500 million share of the loss mitigation or other foreclosure prevention actions in connection with the agreement will be covered by existing loan loss reserves and thus there will be no incremental financial impact to Citi." The company will report its fourth-quarter results on Jan. 17. Citi's shares rose slightly to close at $42.47.

U.S. Bancorp released a statement saying that its "share of the settlement will include a cash payment of $80 million (pretax), which is expected to reduce fourth-quarter 2012 earnings per share by approximately 3 cents. In addition, the settlement includes a commitment to provide approximately $128 million of other mortgage assistance, such as loan modifications, which is covered by existing loan loss reserves." USB will report its fourth-quarter results on Jan. 16. The company's shares pulled back 1%, closing at $32.92.

Following the market close, Wells Fargo announced that it's "portion of the cash settlement will be $766 million, which is based on the proportionate share of Wells Fargo-serviced loans in the overall IFR population." The company also said it would "record a pre-tax charge of approximately $644 million in the fourth quarter of 2012 to fully reserve for its cash payment portion of the settlement and additional remediation-related costs." Wells Fargo's shares had declined slightly, to close at $34.77.

Comptroller of the Currency Thomas J. Curry said in a statement that "when we began the Independent Foreclosure Review, the OCC pledged to fix what was broken, identify who was harmed, and compensate them for that injury. While today's announcement represents a significant change in direction, it meets those original objectives by ensuring that consumers are the ones who will benefit, and that they will benefit more quickly and in a more direct manner."

We have learned a great deal from the reviews that have been conducted to date," Curry said. "However, it has become clear that carrying the process through to its conclusion would divert money away from the impacted homeowners and also needlessly delay the dispensation of compensation to affected borrowers. Our new course of action will get more money to more people more quickly, and it will speed recovery in the nation's housing markets."

Capital One


Capital One's shares have now returned 9% year-to-date, following a 38% return during 2012.

The shares trade for 1.7 times tangible book value, according to Thomson Reuters Bank insight, and for nine times the consensus 2013 EPS estimate of $7.02, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is $7.39.

The company is scheduled to report its fourth-quarter results on Jan 17, with the consensus among analysts being a profit of $1.63 a share, compared to EPS of $2.01 in the third quarter and 88 cents in the fourth quarter of 2011.

The third quarter was the company's first "clean" quarter in 2012, with a very strong return on average tangible common equity of 21.48%. The first and second quarters of 2012 were affected by numerous one-time items springing form Capital One's two transformative mergers. The company in February acquired ING Direct (USA), followed by a $1.25 billion common equity raise in March. Then in May, Capital One purchased HSBC's ( HBC) U.S. credit card portfolio for $2.5 billion.

The ING deal included roughly $80 billion in deposits gathered over the Internet, along with $41 billion in loans, providing plenty of liquidity for the $28.2 billion in credit card loans acquired from HSBC.

FBR analyst Paul Miller on Dec. 19 included Capital One among his list of "stocks to own for 2013," with a price target of $72, saying the company is "one of our favorite names due to its compelling valuation ($72 target = 10x our FY13 EPS estimate and 1.1x book value), expected resumption of the dividend, and increased earnings power."

Morgan Stanley


Morgan Stanley was the Monday's loser among the largest U.S. Banks, with shares sliding 2% to close at 19.80. The shares have now returned 4% year-to-date. The shares returned 28% during 2013, following a 44% decline during 2011.

The shares trade for 0.7 times their reported Sept. 30 tangible book value of $26.65, and for 10 times the consensus 2013 EPS estimate of $1.99. The consensus 2014 EPS estimate is $2.33.

Morgan Stanley pays a quarterly dividend of a nickel a share, and investors are sure to be wondering whether or not the company will request Federal Reserve permission to increase its return of capital to investors, as part of the regulator's next round of annual stress tests, which will be completed in March.

Bank of America Merrill Lynch analyst Michael Carrier has a neutral rating on Morgan Stanley, with a $20 price target, saying in November that there could be "upside potential" for Morgan Stanley to pay out a higher percentage of earnings, following the stress tests. Then again, the analyst also said that the possible regulatory approval for the company to complete its purchase of Citigroup's entire remaining stake in the Morgan Stanley Smith Barney joint venture could "mostly replace" common share buybacks.

Carrier also said that "we value the brokers based on the relationship between ROTE (return on tangible equity) and P/TB (price to tangible book), which has a high historical correlation. Our $20 PO is based on a target P/TB multiple of 0.75x our forward tangible book estimate, which is in line with our forecasted ROTE of roughly 7.5%."

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

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.

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