Bank Stocks Are Strong on Manufacturing Boost

NEW YORK (TheStreet) -- Capital One Financial (COF) was the sector winner on a strong day for bank stocks, with shares rising 2.3% to close at $73.83.

The broad indices all ended with solid gains after the Federal Reserve said industrial production in the United States had increased by 0.6% during February, following a decline of 0.2% in January. The increase for February came in well ahead of consensus estimate of 0.2%, among economists polled by Thomson Reuters. The February increase was the largest since August, and manufacturing during the month was up 2.8% from a year earlier.

Also on Monday, the Empire State manufacturing index for March came in at 5.6, up from 4.5 in February. An index reading above zero indicates expansion.

Economic news was mixed, however, with the National Association of Home Builders/Wells Fargo Housing Market Index for March rising one point from February to 47. An index reading below 50 indicates the majority of builders see market conditions as poor.

The KBW Bank Index (I:BKX) rose 1.2% to 70.40, with all 24 component stocks ending with gains.

Crimea

Investors seemed to take the weekend vote in Crimea to secede from Ukraine and join the Russian Federation in stride, as the U.S. the European union placed sanctions on selected individuals from Russia and Ukraine, including advisors to Russian President Vladimir Putin and former Ukrainian president Viktor Yanukovych, who was ousted last month and now is in Russia.

The expected annexation of Crimea may not signal the end of uncertainty in Eastern Europe, especially when considering the ethnic Russian populations in other former Soviet republics. Protecting Russian speakers from "threats" was Putin's main pretext for Russia's move into Crimea.

"Renewed ethnic clashes could be a catalyst for Russian military intervention beyond Crimea, while the revival of negotiations for an EU Association Agreement could also inflame Russian concerns," Citigroup analyst Tina Fordham wrote in a note to clients on Friday.

"A key positive signpost would be a shift in stance from Moscow, which has thus far declined to negotiate with the new government in Kiev," Fordham wrote.

Fannie and Freddie

Also on Monday, shares of government-sponsored mortgage enterprises (GSEs) Fannie Mae (FNMA) and Freddie Mac (FMCC) showed great volatility after Senate Banking Committee Chairman Tim Johnson (D., S.D.) and ranking committee member Sen. Mike Crapo (R., Idaho) over the weekend proposed the Housing Finance Reform and Taxpayer Protection Act of 2014, which would wind-down the two companies.

Fannie and Freddie were taken under government conservatorship at the height of the credit crises in September 2008. The GSEs' common and preferred stocks remained publicly traded, but values plunged because dividends to non-government shareholders were suspended, and because it appeared highly unlikely at the time at the GSEs would eventually return to being highly profitable.

Under their original bailout agreements, Fannie and Freddie were required to pay the U.S. Treasury 10% annual dividends on the government-held senior preferred shares. However, in August 2012, after the GSEs had returned to profitability and after they had stopped increasing their borrowings from the government, the bailout agreement was changed so that all GSE profits since then have been swept paid to the government, in excess of minimal capital cushions.

Following their March dividend payments, Fannie and Freddie will have paid total dividends of $199 billion on $189.4 billion in senior preferred shares held by the Treasury. Factoring in warrants that were handed to the government to acquire up to 79.9% of the GSEs common shares, Rafferty Capital Markets analyst Richard Bove last recently estimated the government's return on its investment in Fannie and Freddie was $238 billion.

But there's no mechanism in place that allows Fannie or Freddie to repurchase any of the senior preferred shares held by the government, and the dividend sweep also keeps the GSEs from building up capital that could eventually enable them to restore dividends to junior preferred shareholders.

And the Johnson-Crapo bill makes no mention of Fannie or Freddie's common or junior preferred shareholders in its 442 pages.

Congress is leaving it to the courts to decide whether non-government shareholders of the GSEs will get a seat at the table, as the future of U.S. home financing is eventually decided.

For more on what led to the current impasse over Fannie Mae and Freddie Mac and the interests of the various players, please see Were Fannie, Freddie Negotiations Done in Good Faith?, Ralph Nader Discusses Fannie and Freddie Shareholder Fight and Fannie and Freddie Plaintiffs Eye FDIC Share Sales.

Fannie Mae's common shares were down 9.2% to $3.75, while Freddie's common shares were down 9.7% to $3.71 in the last few minutes of trading.  Junior preferred shares of the GSEs were also weak, with Fannie's preferred series S shares (FNMAS) down 1.4% to $60, while Freddie's preferred Series Z shares (FMCKJ) were down 0.6% to $11.13.  Both junior preferred issues have face values of $25, with investors hoping they may trade up to par if their dividends eventually are restored.

Federal Reserve

The Federal Open Market Committee on Tuesday will begin a two-day meeting, to be followed with the release of a policy statement Wednesday afternoon. The committee is expected to continue to wind down the central bank's monthly "QE3" purchases of long-term bonds, which ran at a pace of $85 billion a month from September 2012 through December of last year, with the pace declining to $75 billion in January and $65 billion in February.

Federal Reserve Chairwoman Janet Yellen has said the FOMC expects to wind-down the bond purchases by the end of 2014.

The Fed's massive balance-sheet expansion through QE3 has been meant to hold long-term interest rates down, and the FOMC is looking to return to focusing on its main policy tool -- the short-term federal funds rate -- once the bond purchasing ends.

The federal funds rate has been locked in a target range of zero to 0.25% since late 2008. For some time, the FOMC had set a benchmark of 6.5% for the U.S. unemployment rate, before the committee would consider raising the federal funds rate. Yellen has also indicated the federal funds rate won't move higher until after QE3 ends.

But investors might see new language in Wednesday's FOMC statement hinting at when short-term interest rates may be allowed to rise, because the unemployment rate improved to 6.6% in February from 6.7% in January. A rising federal funds rate will be music to the ears of bankers, since most banks have been continuing to see pressure on their net interest margins, despite a rise in long-term interest rates over the past year. This is because many classes of assets continue to reprice at lower interest rates, since they are pegged to short-term rate benchmarks.

Capital One

Shares of Capital One are down 3.2% this year, following a 34% return during 2013.  The shares trade for 1.7 times the reported Dec. 31 tangible book value of $42.47, and for 10.1 times the consensus 2015 earnings estimate of $7.28, among analysts polled by Thomson Reuters.  The consensus 2014 EPS estimate is $6.81.

The company had a decent 2013, with a return on tangible common equity of 16.05 and a return on average assets of 1.40%, according to Thomson Reuters Bank Insight

What has held the stock back this year appears to be investors' disappointment with the company's declining credit card loan balances.  Average domestic card loans held for investment were $69.739 billion in February, down 2.9% from January.  Card lenders typically see seasonal pressure on loan balances at this time of the year, but Capital One's average domestic card loans held for investment were down 3.5% from a year earlier, in part because of the company's decision to sell its portfolio of over 46 billion in Best Buy credit card loans to Citigroup (C), in transaction completed in September.

The Federal Reserve on Thursday will announce the results of its annual stress tests on 30 major bank holding companies, but the more important date for investors is March 26, when the regulator will announce the results of its second set of stress tests, incorporating banks' plans to deploy excess capital through dividend increases, share buybacks and/or acquisitions.  KBW analyst Sanjay Sakhrani estimates Capital One will receive regulatory approval to raise its quarterly dividend by a nickel to 35 cents a share, and also be approved to repurchase up to $1.837 billion in common shares from the second quarter of 2014 through the first quarter of 2015.

Please see the following for more on what to expect from the stress tests and capital plan reviews:

Discover, Fifth Third Are Well-Positioned for Higher Payouts After Stress Tests

Banks' Excess Capital Is 'Absolutely a Reality'

A 'Compelling' Case for JPMorgan's Stock

Citigroup, Stress Tests and Shareholder Gravy

Why You Should Celebrate Bank Stress Tests

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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