Bank Stocks Pull Back As Employment Growth Disappoints

NEW YORK (TheStreet) -- Bank of New York Mellon (BK) led large U.S. banks lower on Friday, with shares declining 1.5% to close at $34.23.

The broad indices ended mixed, after the Department of Labor said the U.S. economy added 74,000 nonfarm jobs during December, which was a far cry from the average employment growth estimate of 192,000, among economists polled by Reuters.

The KBW Bank Index (I:BKX) on Friday pulled back 0.4% to 70.78, with all but seven of the 24 index components ending lower.

The U.S. unemployment rate continued its rapid decline, to 6.7% in December from 7.0% in November and 7.3% in October.  Economists had expected the unemployment rate for December to remain unchanged at 7.9%.

The "good news" for the unemployment rate in December was been driven in part by a 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.

During 2013, one of the major economic themes was the expected tapering of the Federal Reserve's monthly "QE3" purchases of long-term bonds, meant to hold long-term interest rates down.  The Federal Open Market Committee in December finally announced that the Fed's monthly bond purchases beginning in January would be lowered by $10 billion to $75 billion.  The market yield on 10-year U.S. Treasury bonds has risen accordingly to 2.87% from 1.70% at the end of April.

Even though long-term interest rates remain at historically low levels, this increase has been enough to curtail the wave of mortgage loan refinancing activities banks have enjoyed over the past several years.  Lower mortgage revenue and continued pressure on net interest margins will be major themes for banks' earnings season, which begins on Tuesday, when JPMorgan Chase (JPM) and Wells Fargo (WFC) announce their fourth-quarter results.

Some investors may wonder why banks' margins are continuing to be pressured, since long-term interest rates have risen significantly.  The problem for the banks is that they are positioned to benefit from a parallel rise in interest rates, which can only come about when the Fed raises the short-term federal funds rate, which has been stuck in a range of zero to 0.25% since late 2008.

This makes the unemployment rate a key indicator for 2014, probably overshadowing all of last year's "taper talk."

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, but incoming Fed Chairwoman Janet Yellen and other policymakers may hesitate to raise the federal funds rate, because of the decline in the labor force. 

Bank of New York Mellon

Shares of Bank of New York Mellon trade for 2.6 times their reported Sept. 30 tangible book value of $13.36, and for 12.3 times the  consensus 2015 earnings estimate of $2.78, among analysts polled by Thomson Reuters.  The consensus 2014 EPS estimate is $2.49.  Those valuations are high for a large-cap bank in the current environment, however, all the large trust and custody banks trade rather high when compared to banks with a more traditional lending focus.

The company will announced its fourth-quarter earnings on Jan. 17, with analysts on average expecting earnings of 54 cents a share, down from 60 cents the previous quarter, but up slightly from 53 cents a year earlier.

KBW analyst Robert Lee rates Bank of New York "market perform," with a price target of $35, and in his fourth-quarter earnings preview for trust and custody banks on Jan. 2 wrote, "Overall, servicing fee revenues should benefit modestly from higher equity values, but seasonality in high margin issuer services and incrementally lower [foreign exchange] volatility are headwinds."

Lee estimates Bank of New York Mellon will show fourth-quarter operating EPS of 51 cents, three cents shy of the consensus.  He estimates the company will earn $2.45 a share in 2014, with EPS growing to 2.80% in 2015.

The following chart shows the stock performance of Bank of New York Mellon against the KBW Bank Index and the S&P 500 since the end of 2011: 


BK Chart 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 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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