Bonus-Boosting Rally in U.S. Bank Stocks Seen Fading

Shares of U.S. financial firms just staged their biggest annual rally since 1997, creating a bonanza for Wall Street employees who received bonuses in deferred stock. The new year doesn’t hold the same promise.

The KBW Bank Index of 24 lenders increased 35 percent in 2013, the most in 16 years, and the Standard & Poor’s 500 Capital Markets Index of 13 securities firms and asset managers surged 49 percent, the most on record. Analysts tracked by Bloomberg predict shares of those companies will slip an average of 0.2 percent in 2014.

The rise in share prices that began in October 2011 has been a boon to traders and dealmakers at firms including Morgan Stanley that retooled bonuses after the financial crisis to include more deferred stock. The gains may slow as valuations near or exceed historic norms and the Federal Reserve phases out a policy that suppressed interest rates and boosted equities.

“It could be difficult for stock prices to generate similar gains in 2014,” Terry McEvoy, an analyst at Oppenheimer & Co., said in an interview. Financial firms are still operating in “a challenging environment to grow revenue,” he said.

Bank stocks “no longer appear cheap” and probably won’t perform better than the broader market this year, Christopher Mutascio, a Baltimore-based analyst at Stifel Financial Corp.’s KBW unit, wrote in a Dec. 11 note to clients. Lenders in the KBW Bank Index are trading at about 80 percent of the S&P 500 Index’s price-to-earnings ratio, above the 18-year average of about 76 percent, he wrote.

Broad Rally

Shares of financial firms were part of a market-wide surge last year that drove the S&P 500 up 30 percent. While the narrower S&P 500 Financials Index rose 33 percent, it trailed gains by consumer, health-care and industrial companies.

The Fed’s efforts and a gradually improving economy pushed U.S. equities higher, said Shannon Stemm, an analyst at Edward Jones & Co. in St. Louis. Financial stocks rose even as mortgage fees declined, Wall Street grappled with a slump in fixed-income trading and firms settled legal claims and regulatory probes stemming from the financial crisis.

“If you take it back to the banks specifically, this has not been a very good year for revenue growth,” Stemm said.

During the first nine months of 2013, combined net revenue at companies in the KBW Bank Index rose 2.6 percent from the same period a year earlier, according to data compiled by Bloomberg. JPMorgan Chase & Co., the biggest U.S. lender, and Wells Fargo & Co., the fourth-largest, are scheduled to lead U.S. banks in reporting fourth-quarter results starting Jan. 14.

‘Eventual Trade’

The Fed said Dec. 18 that it will reduce its monthly bond purchases to $75 billion from $85 billion, reflecting an improved economic outlook. The nation’s jobless rate fell to a five-year low of 7 percent in November, and gross domestic product expanded at a 4.1 percent annualized rate in the third quarter, the fastest since 2011. On the day of the Fed’s announcement, the KBW Bank Index rose the most in 40 days.

Short-term rates, which the Fed has held to 0.25 percent since 2008, may not rise until 2015, according to 15 of 17 Federal Open Market Committee participant forecasts. After that happens, net interest margins, or the difference between what a bank pays on deposits and gets for loans, could expand and boost income.

“I call it the eventual trade,” said Oppenheimer’s McEvoy, who is based in Portland, Maine. “Eventually we all know the short end of the yield curve will go up, and that will drive an improvement in bank profitability and support higher stock prices.”

If forecasts change to signal that Fed rates will rise sooner, that could boost bank stocks in 2014, McEvoy said.

Consumer Confidence

The Fed’s decision to taper its bond buying bodes well for banks because an improving economy could spur more confidence among consumers and businesses to borrow, Gerard Cassidy, an RBC Capital Markets analyst also based in Portland, said in a phone interview. Annual GDP is forecast to rise to 2.6 percent in 2014, according to a Bloomberg survey.

“We anticipate stronger loan growth in 2014 versus ’13, driven by the economy,” Cassidy said.

Investors could turn to JPMorgan and Bank of America Corp. shares to take advantage of a stronger U.S. economy, Keith Horowitz, a Citigroup Inc. analyst, said today in a note to clients. Shareholders are also showing confidence that Goldman Sachs Group Inc. and Morgan Stanley will push returns above their cost of capital, “even though it will take several years to get there,” he wrote.

Share Forecasts

That rosy forecast isn’t shared by all analysts. Some say financial firms’ stock prices don’t have much room to run.

“Valuations have reached more normalized levels for most groups, and we are not expecting a repeat of the 2013 performance,” Bank of America analysts including Erika Najarian wrote in a Dec. 16 note to investors.

Bank revenue “may not heal” this year and companies are running out of ways to continue reducing credit costs to boost earnings per share, Najarian wrote.

Global regulators pushed banks after the 2008 crisis to overhaul bonuses by delaying payouts and making them subject to clawbacks. The shift is meant to discourage employees from taking outsize risks for quick rewards. The deferred-stock grants ended up benefiting workers who typically prefer cash, said Steven Hall, a founder of Steven Hall & Partners, a New York-based executive-compensation consulting firm.

‘Decent Deal’

“Think of everybody that’s been paid equity since the stock market fell apart in 2008, 2009, and they’ve been getting it with vesting of three or five years,” Hall said. “They’ve been forced into the stock. They’ve got a pretty decent deal.”

Morgan Stanley shares jumped 64 percent last year after the firm required senior bankers and traders to defer their entire 2012 bonus, of which half will be paid in stock. The policy, described last January by a person briefed on the decision, applied to employees who made more than $350,000 and got incentive pay of at least $50,000.

The firm now plans to pay a larger share of bonuses for 2013 in cash, the Wall Street Journal reported on Dec. 23, citing unidentified people familiar with the plans. Analysts tracked by Bloomberg predict New York-based Morgan Stanley will rise 3.6 percent over the next 12 months.

That’s near the average 3.8 percent increase that analysts forecast for the six biggest U.S. banks -- JPMorgan, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley -- in 2014, according to data compiled by Bloomberg. And it’s about 1/10 the average 39 percent gain in their shares last year.


Most large U.S. banks make stock the biggest piece of their chief executive officers’ compensation, setting it to vest over years. For Goldman Sachs CEO Lloyd C. Blankfein, 59, restricted stock accounted for 63 percent of his $21 million pay package for 2012, not including a $5 million cash incentive tied to future performance, according to company filings. Shares of the New York-based firm rose 39 percent last year, boosting the value of Blankfein’s award for that year by $3.4 million.

JPMorgan CEO Jamie Dimon, whose pay for 2012 was cut in half to $11.5 million after the board faulted his oversight of botched derivatives bets, got $10 million in restricted stock units. Shares of the New York-based lender climbed 33 percent last year, giving Dimon, 57, a $2.6 million profit on paper.

Wells Fargo granted CEO John Stumpf, 60, more than $12.5 million in equity-linked incentives last year. The San Francisco-based firm advanced 33 percent last year. Bank of America CEO Brian T. Moynihan, 54, was awarded three types of restricted stock totaling $11.05 million. Shares of the Charlotte, North Carolina-based company increased 34 percent last year. Citigroup gave $6.27 million of so-called performance share units and deferred stock to CEO Michael Corbat, 53. The New York-based bank rose 32 percent in 2013.

No Decliners

All of the companies in the KBW Bank Index rose in 2013, the first time that’s happened in a decade. The best performer was Cleveland-based KeyCorp, which gained 59 percent. The worst performer, Buffalo, New York-based M&T Bank Corp., advanced 18 percent. Every company also rose in the S&P Capital Markets Index, which includes Goldman Sachs and Morgan Stanley, as well as asset managers BlackRock Inc. and Legg Mason Inc.

The rally may help firms overcome employee resistance to deferred-stock payouts, Hall said.

‘Mild Correction’

“What happens when the music stops, does that create any problems?” he said. “It probably gets people cranky, but they’ll be in a situation at least for a while where the amount of gains that they’re still sitting on will overwhelm whatever could take place, if you see some kind of a mild correction.”

Debt markets also warmed to U.S. banks last year. For the first time since the crisis, bond buyers showed more confidence in financial firms than in industrial companies. Relative yields on bonds from Morgan Stanley to Wells Fargo were 13 basis points less than the average for industrial notes on Dec. 30, according to index data from Bank of America Merrill Lynch.

Bond buyers boosted their confidence in bank debt as lenders built deposits to record highs of $9.74 trillion and bolstered capital cushions to meet regulations designed to avert another banking crisis.

Stock investors may be more discerning when investing in banks in the coming year, Mutascio wrote in his note. Some past contributors to profits -- including mortgage fees and reduced provisions for loan losses -- may contribute less to earnings growth, he said.

“Investors will eventually migrate towards banks that have demonstrated the ability to generate better-than-peer profitability throughout various economic scenarios and environments,” Mutascio said.

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