Bank Stocks Move Higher as Strong Jobs Report Offsets Tapering Talk

NEW YORK (TheStreet) -- Stocks of large regional U.S. banks gained Wednesday following a strong jobs report that bodes well for the Department of Labor's monthly figures scheduled to be issued on Friday.

Major stock indices ended mixed after the Automatic Data Processing's National Employment Report showed that 238,000 non-farm private-sector jobs were added to the U.S. economy in December.  The better-than-expected additions followed 229,000 jobs which were added in November. December was the strongest month during 2013 for private-sector employment growth, ADP said. The consensus among economists polled by Reuters was for the ADP number for December to come in at 205,000.

While the broad market's negative reaction to the ADP indicated investors' concern over a continued tapering of Federal Reserve bond purchases and the eventual lifting of the short-term federal funds rate, most bank stocks ended with gains. 

The KBW Bank Index (I:BKX) was up 0.8% to 70.50, with all but two of the 24 index components ending higher. The sector leader on Wednesday was PNC Financial Services Group (PNC) of Pittsburgh, with shares rising 1.6% to $78.64.

The Department of Labor will report the December U.S. unemployment rate on Friday.  The unemployment rate for November declined to 7.0% from 7.3% in October. 

As for Fed tapering and its potential impact on equities, let's recall that there was plenty of hysteria in business media circles last year leading up to the U.S. central bank's decision to start reducing its purchases of long-term bonds, a measure that was finally announced in December.

For 2014, it's likely the media will become equally fixated on the federal funds rate, which has been held in a target range of zero to 0.25% since late 2008. The Federal Open Market Committee has repeatedly said it was unlikely to raise the target for the federal funds rate until the unemployment rate drops below 6.5%. 

Even though former Fed chairman Ben Bernanke said it would probably take some time after that for the federal funds rate to be raised, 6.5% is now a "magic number" for market watchers, so quite a bit is riding on Fridays unemployment number.

Jefferies analyst Ken Usdin on Wednesday initiated coverage for three of the largest U.S. banks, writing in a report that even after the stellar returns of the last two years, "this group offers attractive risk/return profiles."  While acknowledging that the big banks "never free from controversy and incrementally burdened by regulation," Usdin assigned "buy" ratings to Bank of America (BAC) and JPMorgan Chase (JPM).  He went with a "hold" rating for Citigroup (C), writing that "investors must be patient" for the bank's capital return story to unfold.

Bank of America's shares rose 0.6% to $16.59, while JPMorgan was up 0.9% to $58.87, and Citi's shares climbed 1.2% to close at $54.81.

Fannie and Freddie

Shares of Fannie Mae (FNMA) and Freddie Mac (FMCC) were very strong on Wednesday, after comments at a Financial Services Round Table meeting indicated a willingness in Congress to consider the interests of private investors when winding down the two government sponsored enterprises (GSEs).

Fannie's common shares were up over 5% to $3.24, while Freddie's common shares rose nearly 7% to $3.14.

The GSEs' junior preferred shares popped, with Fannie Mae's preferred Series F shares (FNMAS) rising 15% to $10.04, while Freddie's preferred Series Z (FMCKJ) shares were up 12% to $10.15. Both preferred issues have par values of $25.00.

The GSEs were taken under government conservatorship at the height of the credit crisis in September 2008.  The U.S. Treasury holds $117.1 billion in senior preferred Fannie Mae shares and $72.3 billion in senior preferred Freddie Mac shares. Under their modified bailout agreements, the GSEs must pay all earnings to the government in excess of minimal capital cushions of $3 billion apiece. Including their December dividend payments, the government has received $185.3 billion in dividends from Fannie and Freddie, for a five-year investment of $189.4 billion.

But there's no mechanism in place for either GSE to repurchase any government-held preferred shares.  Several institutional investors holding junior preferred and/or common shares of Fannie and Freddie have sued the government over what they say has been an illegal seizure of their property. 

Senators Bob Corker (R., Tenn.) and Mark Warner (D., Va.) last June introduced the Housing Finance Reform and Taxpayer Protection Act, which would replace Fannie and Freddie with a privately capitalized mortgage finance system.

During the round table discussion, Corker "reiterated that the Fairholme plan proved there was an appetite for risk from the private sector, an issue that drew scepticism from critics of the Corker-Warner bill. White House officials have rejected the hedge fund proposal,"  according to a Financial Times report.

The Financial Times also  reported Warner's off-the-cuff remarks during the Round Table discussion to mean "a strong bipartisan bill that garnered the most support was the best way to success, hinting that the final outcome could be a combination of proposals. He added that those advocating for the status quo for Fannie and Freddie, which are under government conservatorship, were pushing for the wrong outcome."

That sort of talk in Washington is just what investors holding junior preferred and common shares of the GSEs want to hear.

U.S. Bancorp

Also on Wednesday, Jim Cramer said he was "really annoyed" with a downgrade by Credit Suisse of U.S. Bancorp USB to a "neutral" rating from an "outperform" rating, since the company "just picked some great branches," and because "has historically been one of the best banks in the country."

U.S. Bancorp on Tuesday announced a deal to acquire Charter One's Bank's 94 branches in Chicago from RBS Citizens Financial Group, which is a subsidiary of Royal Bank of Scotland RBS.  USB will take on 800 Charter One employees, along with $5.3 billion in deposits and $1.1 billion in loans, paying a premium of $315 million, or 6%, on the deposits.

For the first three quarters of 2013, U.S. Bancorp's return on average tangible common equity (ROTCE) was 24.18%, which was, by far, the strongest performance among the 24 components of the KBW Bank Index.

Over the previous three full years through 2012, U.S. Bancorp's ROTCE improved from 18.36% during 2010 to 22.28% during 2012, according to Thomson Reuters Bank Insight.

U.S. Bancorp's stock rose 0.4% Wednesday to close at $41.09.

The shares trade for 3.1 times tangible book value, and for 11.3 times the consensus 2015 earnings estimate of $3.65 a share, among analysts polled by Thomson Reuters.  The consensus 2014 EPS estimate is $3.19.   That price-to-tangible book value ratio is rather high, but it reflects USB's status as a consistently strong earner, with few of the surprises that have plagued so many other large banks.  The forward P/E valuation is a different story, representing a rather slight premium to other large-cap banks with considerably weaker track records.

The following chart shows USB's performance against the KBW Bank Index and the S&P 500 since the end of 2011: 

USB ChartUSB data by YCharts

-- 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 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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