Banking Sector Job Cuts: How to Profit

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In a recent Bloomberg interview, analyst Meredith Whitney said that, “Wall Street is just going to have an extremely challenged revenue environment for the foreseeable future.” She anticipates 50,000 to 100,000 layoffs in the financial sector as a response to the sales drought.

Many financial service companies are struggling in a deleveraging, slower-growing world. To cope with this “New Normal” world, many financial service companies around the world are laying-off employees to cut costs. In light of declining revenue projections, investors dead-set on investing in the financial sector should look to sales and profit margin to select the best positioned financial stocks.

Layoffs in Finance are an International Language

The second-largest lender in the U.S., Bank of America (BAC) announced a year ago that it plans to cut more than 30,000 employees over several years. The third largest American bank, Citigroup (NYSE: C) has also announced job cuts although it has not commented on how many. Joining the pack, Morgan Stanley (MS) has stated that it expects to cut about 700 employees in the second half of the year, which will bring its total job cuts to about 4,000 for the entire year.

This is truly a global phenomenon. Banks and other financial institutions in the are also expected to cut about 3,000 employees in the Greater London area this year. HSBC (NYSE: HBC), has stated that it plans to cut about 3,200 jobs in the United Kingdom, claiming most of these job losses will be in the middle to senior management areas. Deutsche Bank (NYSE: DB), the largest lender in Germany also expects to cut almost 2,000 jobs, mainly in its investment bank which operates in London and New York. Many of these job cuts are happening as banks work to comply with new capital requirements that will take effect in 2013.

Even though many banks around the world are cutting jobs, Canada’s financial companies seem to be exceptions. The Royal Bank of Canada (RY) added over 8,500 full time employees from May to July 2012, a 2.5% increase. This is more 1,5000 more than the 7,000 employees added through acquisitions. Canada's third largest lender, Bank of Nova Scotia (BNS) is expected to add over 1,000 employees once it completes its takeover of ING Bank of Canada from ING (ING), which was announced recently. Toronto-Dominion Bank (TD) added almost 800 employees during the third quarter, Scotiabank added over 300 jobs, and National Bank of Canada added a little over 200 employees. Although many Canadian banks are currently increasing their workforce, history has shown that they typically cut some jobs during the fourth quarter in preparation for the end of the year.

Europe's biggest bank, Deutsche Bank, is planning to cut costs by $6 billion through job cuts and by reviewing its pay practices in order to help increase profitability. Management compensation curbs include smaller bonus pools and increased vesting period for deferred bonuses among management. In addition, employees are being moved from 40 locations to lower-cost locations. The company has already slashed 2,000 jobs and warns that it will continue to reduce head count.

Deutsche Bank is putting together an external compensation panel to review its compensation procedures, its co-CEO has stated that the bank has chosen the chair for this panel, but has not yet identified who. The panel will consist of industry leaders from the U.S., the U.K., Germany, and the Asia Pacific region. The bank has stated that the panel will formulate and implement principles and standards for future compensation structures and practices, and help define the appropriate disclosure level.

Evaluating Financials

There are many large cap financial stocks available to U.S. investors. In a world of deleveraging we should think about revenue and profit margins as key metrics. Investors should use the price-to-sales metric as well as net profit margins to rank stock investment opportunities in terms of cheapness and safety.

In order to have a clean comparison, operating margins were used to evaluate large banks instead of profit margins. This substitution was made to avoid discrepancies in the timing of asset write-downs and other accounting decisions which can be “gamed” by management. The regression of operating margins on the price-to-sales ratio had an R-squared value of 0.41, which means that 41% of the variance in profit margin is explained by differences in the price-to-sales ratio. This linear model was used to calculate an estimated operating margin given a stock’s cheapness based on the price-to-sales ratio. The extent to which operating margins were above-trend for a stock appears under the “excess operating margin” column.

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>Country</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>Operating Margin</strong></p> </td> <td> <p><strong>Modeled Operating Margin</strong></p> </td> <td> <p><strong>Excess Operating Margin</strong></p> </td> </tr> <tr> <td> <p>(LYG)</p> </td> <td> <p>Lloyds Banking Group</p> </td> <td> <p>UK</p> </td> <td> <p>1.07</p> </td> <td> <p>-2.75%</p> </td> <td> <p>9.93%</p> </td> <td> <p>-12.68%</p> </td> </tr> <tr> <td> <p>(CS)</p> </td> <td> <p>Credit Suisse Group</p> </td> <td> <p>Switzerland</p> </td> <td> <p>1.23</p> </td> <td> <p>5.04%</p> </td> <td> <p>11.27%</p> </td> <td> <p>-6.23%</p> </td> </tr> <tr> <td> <p>(BCS)</p> </td> <td> <p>Barclays</p> </td> <td> <p>UK</p> </td> <td> <p>1.32</p> </td> <td> <p>13.71%</p> </td> <td> <p>12.02%</p> </td> <td> <p>1.69%</p> </td> </tr> <tr> <td> <p><strong>(C)</strong></p> </td> <td> <p><strong>Citigroup</strong></p> </td> <td> <p><strong>USA</strong></p> </td> <td> <p><strong>1.42</strong></p> </td> <td> <p><strong>18.25%</strong></p> </td> <td> <p><strong>12.85%</strong></p> </td> <td> <p><strong>5.40%</strong></p> </td> </tr> <tr> <td> <p>(RBS)</p> </td> <td> <p>The Royal Bank of Scotland</p> </td> <td> <p>UK</p> </td> <td> <p>1.42</p> </td> <td> <p>-5.93%</p> </td> <td> <p>12.85%</p> </td> <td> <p>-18.78%</p> </td> </tr> <tr> <td> <p>(BAC)</p> </td> <td> <p>Bank of America</p> </td> <td> <p>USA</p> </td> <td> <p>1.65</p> </td> <td> <p>14.07%</p> </td> <td> <p>14.77%</p> </td> <td> <p>-0.70%</p> </td> </tr> <tr> <td> <p><strong>(SAN)</strong></p> </td> <td> <p><strong>Banco Santander-Chile</strong></p> </td> <td> <p><strong>Chile</strong></p> </td> <td> <p><strong>1.95</strong></p> </td> <td> <p><strong>23.63%</strong></p> </td> <td> <p><strong>17.28%</strong></p> </td> <td> <p><strong>6.35%</strong></p> </td> </tr> <tr> <td> <p><strong>(WBK)</strong></p> </td> <td> <p><strong>Westpac Banking</strong></p> </td> <td> <p><strong>Australia</strong></p> </td> <td> <p><strong>1.95</strong></p> </td> <td> <p><strong>49.49%</strong></p> </td> <td> <p><strong>17.28%</strong></p> </td> <td> <p><strong>32.21%</strong></p> </td> </tr> <tr> <td> <p>(MTU)</p> </td> <td> <p>Mitsubishi UFJ Financial</p> </td> <td> <p>Japan</p> </td> <td> <p>2.07</p> </td> <td> <p>9.16%</p> </td> <td> <p>18.28%</p> </td> <td> <p>-9.12%</p> </td> </tr> <tr> <td> <p>(STI)</p> </td> <td> <p>SunTrust Banks</p> </td> <td> <p>USA</p> </td> <td> <p>2.56</p> </td> <td> <p>11.40%</p> </td> <td> <p>22.37%</p> </td> <td> <p>-10.97%</p> </td> </tr> <tr> <td> <p><strong>(CM)</strong></p> </td> <td> <p><strong>Canadian Imperial Bank of Commerce</strong></p> </td> <td> <p><strong>Canada</strong></p> </td> <td> <p><strong>2.63</strong></p> </td> <td> <p><strong>31.86%</strong></p> </td> <td> <p><strong>22.95%</strong></p> </td> <td> <p><strong>8.91%</strong></p> </td> </tr> <tr> <td> <p>(JPM)</p> </td> <td> <p>JPMorgan Chase</p> </td> <td> <p>USA</p> </td> <td> <p>2.66</p> </td> <td> <p>26.26%</p> </td> <td> <p>23.20%</p> </td> <td> <p>3.06%</p> </td> </tr> <tr> <td> <p>(UBS)</p> </td> <td> <p>UBS</p> </td> <td> <p>Switzerland</p> </td> <td> <p>2.7</p> </td> <td> <p>14.71%</p> </td> <td> <p>23.54%</p> </td> <td> <p>-8.83%</p> </td> </tr> <tr> <td> <p><strong>(BMO)</strong></p> </td> <td> <p><strong>Bank of Montreal</strong></p> </td> <td> <p><strong>Canada</strong></p> </td> <td> <p><strong>2.73</strong></p> </td> <td> <p><strong>30.88%</strong></p> </td> <td> <p><strong>23.79%</strong></p> </td> <td> <p><strong>7.09%</strong></p> </td> </tr> <tr> <td> <p><strong>(HBC)</strong></p> </td> <td> <p><strong>HSBC</strong></p> </td> <td> <p><strong>UK</strong></p> </td> <td> <p><strong>2.84</strong></p> </td> <td> <p><strong>29.84%</strong></p> </td> <td> <p><strong>24.71%</strong></p> </td> <td> <p><strong>5.13%</strong></p> </td> </tr> <tr> <td> <p>(PNC)</p> </td> <td> <p>PNC Financial Services</p> </td> <td> <p>USA</p> </td> <td> <p>3.35</p> </td> <td> <p>24.88%</p> </td> <td> <p>28.96%</p> </td> <td> <p>-4.08%</p> </td> </tr> <tr> <td> <p>(TD)</p> </td> <td> <p>The Toronto-Dominion Bank</p> </td> <td> <p>Canada</p> </td> <td> <p>3.49</p> </td> <td> <p>32.58%</p> </td> <td> <p>30.13%</p> </td> <td> <p>2.45%</p> </td> </tr> <tr> <td> <p><strong>(BNS)</strong></p> </td> <td> <p><strong>The Bank Of Nova Scotia</strong></p> </td> <td> <p><strong>Canada</strong></p> </td> <td> <p><strong>3.59</strong></p> </td> <td> <p><strong>40.19%</strong></p> </td> <td> <p><strong>30.96%</strong></p> </td> <td> <p><strong>9.23%</strong></p> </td> </tr> <tr> <td> <p>(WFC)</p> </td> <td> <p>Wells Fargo</p> </td> <td> <p>USA</p> </td> <td> <p>3.79</p> </td> <td> <p>31.19%</p> </td> <td> <p>32.63%</p> </td> <td> <p>-1.44%</p> </td> </tr> <tr> <td> <p>(RY)</p> </td> <td> <p>Royal Bank of Canada</p> </td> <td> <p>Canada</p> </td> <td> <p>3.91</p> </td> <td> <p>31.77%</p> </td> <td> <p>33.64%</p> </td> <td> <p>-1.87%</p> </td> </tr> <tr> <td> <p>(BAP)</p> </td> <td> <p>Credicorp</p> </td> <td> <p>Peru</p> </td> <td> <p>5.24</p> </td> <td> <p>32.73%</p> </td> <td> <p>44.74%</p> </td> <td> <p>-12.01%</p> </td> </tr> </tbody> </table>

There are several banks which have better operating margins than would be expected given their price multiples. They hail from the commodity exporting countries of Canada, Chile, and Australia. Notably, Citigroup is an American bank which has above-trend operating margins. HSBC is a similarly attractive bank from the United Kingdom.

Investors who wish to invest in financials should consider Citigroup, HSBC, Westpac Banking, the Bank of Nova Scotia, and Banco Santander-Chile as additions to their portfolio. This selection is diversified across different economies. It also provides the highest margins and most revenues per invested capital, which make these banks the best able to weather declining sales.

InsiderMonkey has no positions in the stocks mentioned above. The Motley Fool owns shares of Microsoft. BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Citigroup Inc and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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