Bank Investors Fear More Than Oil
If you believe the top executives at the biggest U.S. banks, you'd think there wasn't much to worry about in credit markets outside of the energy space.
For example, on Tuesday morning Bank of America's chief financial officer, Paul Donofrio, said that he had not seen asset quality change much outside of energy, that credit-card losses were at a "historic low point" and that loan growth should be in the mid-single digits. Last week, JPMorgan Chase CEO Jamie Dimon said corporate debt and credit card conditions were as good as they've ever been. Beyond energy, the loan portfolio is in "excellent shape," Citigroup CFO John Gerspach said.
The problem? The market doesn't seem to believe that the deterioration in credit will remain quarantined. The KBW Bank Index is down 14 percent this year, trading near the lowest level since October 2013. The index of 24 banks has plunged more than 20 percent since it peaked in July at the highest level since the Lehman Brothers bankruptcy in 2008. Shares of Bank of America, Citigroup, Wells Fargo and JPMorgan are all down by double-digit percentages this year.
Energy loans do not make up a huge portion of any of these banks' business -- in the neighborhood of about 2 percent of the loan book at Wells Fargo and Bank of America, for example -- and banks have been building reserves to prepare for losses from the commodities sector. Should oil remain at or below $30 a barrel for an extended time, banks will have to book even more provisions. Building reserves to 10 percent of energy loans implies a reduction in earnings of about 2 percent to 6 percent for 2016, according to Goldman Sachs analysts.
However, the market seems to be bracing for something worse. The price-to-book ratios are below 1 for all of these four except Wells Fargo, meaning the stocks are trading for less than the value of the companies' assets minus liabilities. This isn't a new phenomenon -- Citigroup hasn't traded above book value since the financial crisis. But the valuations keep plumbing new lows. The KBW Bank Index itself dipped below book value about a week ago for the first time since 2013; the ratio is currently about 0.94 for the index. This may suggest that investors are worried that the weakness in credit markets will spill over into industries outside of energy.
Other concerns center on whether the volatile trading environment will continue to crimp capital-markets activity and whether optimism about bank profits receiving a boost from higher net-interest margins was overblown now that it's not clear how strong the Federal Reserve's commitment to increasing borrowing costs will be for the rest of the year.
While most banks have beaten earnings estimates for the fourth quarter, the bar was lowered considerably before the reports came rolling in. And while banks are making headlines for beating estimates, the growth in fourth-quarter earnings (or lack thereof) was nothing to brag about:
While Goldman Sachs analysts led by Richard Ramsden lowered price targets and earnings forecasts for Citigroup, JPMorgan, PNC Financial Services, US Bancorp, and Wells Fargo on Tuesday, the targets still imply an average 21 percent total return. As the title of the report makes clear, the analysts believe the "share price pain exceeds credit strain." The analysts conclude: "Risks to the upside for the group include a stronger economic environment and a quicker than anticipated rise in rates, while risks to the downside include tougher capital regulation, a slower rise in rates, and a deterioration in economic conditions."
With banks erasing an early advance Tuesday and many setting new lows, investors for the moment seem to be betting on the latter.
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