Bank Rally May Fade as Revenue Trails 34% Profit JumpLaura Marcinek and Donal Griffin
The six biggest U.S. banks are projected to post a 34 percent increase in first-quarter profit. That may fail to prolong an 18-month rally in their shares as the firms struggle to boost revenue.
The banks are set to report $19.9 billion in combined net income, analysts’ estimates compiled by Bloomberg show, with New York-based JPMorgan Chase & Co. and Wells Fargo & Co. first to announce results on April 12. Revenue will climb just 2.2 percent, the data show. Since the end of 2011, the six banks’ shares have closed the gap with analysts’ price targets, signaling a possible end to the stock surge.
Bank of America Corp. led financial stocks higher as firms resolved legal disputes, Federal Reserve policies spurred a rebound in fixed-income trading and Europe contained its sovereign-debt crisis. Lenders also added to profit by tapping funds that had been designated to cover loan losses. Now, as that income source runs dry, investors are looking for banks to boost profit with revenue growth, said Matt McCormick, a money manager at Bahl & Gaynor Investment Counsel Inc. in Cincinnati.
“Eventually these guys have to get earnings from non-accounting functions,” said McCormick, who helps oversee about $9 billion. “They’re going to have to focus on organic revenue, organic earnings. And when they’re not there, the momentum will fade.”
Banks may have struggled to boost revenue in the first three months of the year amid flagging demand for loans and a decline in mergers and acquisitions after deals surged to a four-year high in the fourth quarter. Economic growth in the U.S. has held below 3 percent since 2006, and unemployment has topped 7 percent since 2008.
“It’s not a robust environment,” said Michael Holland, who oversees more than $4 billion in assets including bank stocks as chairman of Holland & Co. “When the actual numbers come out, it’ll give some people an excuse to take some profits. It’s been a nice run.”
The 81-company Standard & Poor’s 500 Financials Index climbed 54 percent in the 18 months ended March 31, outpacing the 39 percent advance for the broader S&P 500 Index. Of the six largest lenders, the top performer was Bank of America, led by Chief Executive Officer Brian T. Moynihan, 53, which doubled.
JPMorgan, the biggest U.S. bank, is expected to report net income rose 13 percent to $5.5 billion, according to analysts surveyed by Bloomberg. Profit at Wells Fargo, the fourth-largest lender, is set to climb 13 percent to $4.8 billion.
Analysts predict that Citigroup Inc.’s net income will rise 22 percent to $3.6 billion and that Bank of America’s will surge to $2.8 billion from $653 million. Goldman Sachs Group Inc. may say net income fell 6.7 percent to $1.97 billion, and Morgan Stanley’s is expected to be $1.15 billion, after a loss of $94 million a year earlier.
The environment for banking isn’t improving, and the lenders’ ability to bolster profit from tapping loan-loss reserves is waning, which could squeeze profit, said Charles Peabody, an analyst at Portales Partners LLC.
JPMorgan, Bank of America, Wells Fargo and New York-based Citigroup had $68.4 billion of combined pretax profit last year. Reserve releases amounted to about $18 billion, or 26 percent of the total, according to data compiled by Bloomberg. Analysts estimate pretax profit for those firms will be $101 billion this year, with reserve releases accounting for 7.4 percent.
“Where most people have been making their money is on the bottom line and not the top line,” said Alex Lieblong, whose Key Colony Management LLC managed at least $134 million at the end of 2012. “That won’t last forever.”
At the end of 2011, Bank of America traded at 58 percent of the target price set by analysts, according to data compiled by Bloomberg. Now it’s 95 percent. The average for the six banks is currently 90 percent, compared with about 70 percent at the end of 2011.
The narrowing of the gap shows a disconnect between analysts’ price targets and their stock recommendations, as most of those surveyed by Bloomberg continue to advise that investors buy shares in the biggest Wall Street banks.
“The stocks are still cheap, fundamentals are improving and bank cycles generally are long,” Chris Kotowski, an Oppenheimer & Co. analyst, said in an April 4 note. Of the 35 analysts covering Citigroup, just four are urging their clients to sell, according to data compiled by Bloomberg. Three out of 38 with ratings on JPMorgan and five of 39 covering Bank of America have sell ratings.
Culling staff has helped the six biggest banks bolster profit. In the first quarter, the firms announced plans to eliminate about 21,000 positions, or 1.8 percent of their combined workforce, according to data compiled by Bloomberg. JPMorgan leads the group in announced cuts, with 17,000 scheduled by the end of next year.
Banks also benefited from a boost in fixed-income trading in 2012 as a result of the Fed’s so-called quantitative easing program, which ballooned the central bank’s assets beyond $3 trillion as it seeks to keep long-term borrowing costs low to spur economic growth and employment.
Revenue from trading fixed-income securities jumped 21 percent to $92 billion in 2012 from a year earlier, almost a return to levels in 2010, when sales from that business hit $98 billion, according to industry analytics firm Coalition Ltd.
Fed Chairman Ben S. Bernanke has kept short-term borrowing rates close to zero, increasing demand for higher-yielding, riskier debt, or junk bonds, which Wall Street firms helped clients sell to investors at a record pace in 2012.
Bernanke could fail, leading to a recession this year, Peabody said in a phone interview. This would be led by a “grinding halt” in the fixed-income market as prices decline, he said.
Lenders such as JPMorgan and San Francisco-based Wells Fargo also may see diminished performance at their mortgage-banking units, which thrived as low interest rates encouraged customers to refinance. Still, bank executives including Wells Fargo Chief Financial Officer Timothy Sloan have said that won’t last forever.
The pace of mortgage originations began declining in the second half of last year and that probably will continue, Sloan said in February.
“The big worry for a lot of investors is the mortgage business,” said Jennifer Chang, an analyst with Schafer Cullen Capital Management Inc., which oversees about $12.3 billion. “The earnings in the mortgage-banking business are not going to be as good as they were in the last couple of quarters.”
Bank shares jumped amid gains in Fed-supported fixed-income trading, mortgage banking and less investor pessimism about Europe’s debt crisis. Citigroup advanced 73 percent in the 18 months ended March 31. JPMorgan rose 58 percent, Morgan Stanley 63 percent, Goldman Sachs 56 percent and Wells Fargo 53 percent.
“Our enthusiasm for ongoing sector outperformance has waned,” Raymond James & Associates analysts said in a note today. “We now see a period where bank stocks perform more closely with the market as a whole until there are greater signs of accelerating economic growth, business/credit expansion and sustainably higher interest rates.”
Some of the biggest banks, including Morgan Stanley, Citigroup and Charlotte, North Carolina-based Bank of America, still trade for less than tangible book value, a measure of what investors would pay for a company in a liquidation.
Banks trading at a discount have rebounded to about 90 percent of their tangible book value since the end of 2011, when it was 0.53 times for Citigroup, 0.59 for New York-based Morgan Stanley and 0.44 for Bank of America, according to data compiled by Bloomberg.
“Anything that we’ve experienced to date in the stock markets has been nothing but a valuation rally spurred on by liquidity and hope, and not by an underlying, sustainable, fundamental improvement,” Peabody said.