Are Banks a Good Play in a Quantitatively Eased World?
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Now that the Fed has announced QE3, we believe that several funds may be set to capitalize on the policy’s impact on financials. The founder of Fairholme Funds, Bruce Berkowitz, believes there is much value to be found in the sector (see Bruce’s top picks), with his fund heavily weighted toward the U.S.’ biggest banks. Fairholme has kept over 75% of its 13F portfolio in financials for several years now.
In addition to Berkowitz, we believe that several funds saw the wishy-washy economy earlier this year, and the heated talks of QE3 going into 2Q as a potential entry point into financials, believing that QE3 could serve as a solid tailwind toward price appreciation.
One of the biggest factors of QE3 will be Ben Bernanke and the Fed’s intent to keep the federal funds target range for interest rates held between 0-0.25% until at least mid-2015. Lower interest rates are usually bad for financial institutions, given that NIM – net interest margin – is usually a finance company’s primary revenue driver. There is no doubt that a continued tight NIM will put pressure on financial institutions’ bottom lines. However, the initiative by the Fed to stabilize the housing market should prove to be more of a positive for banks and their balance sheets.
American International Group (NYSE: AIG), still partially owned by the U.S. Government, reported Q2 after-tax operating profit of $1.06 per share, which beat estimates of $0.57 as well as the $0.68 AIG earned in the same quarter last year. Book value saw a modest increase of 4% to $56.07 per share, which is still well above the stock’s current share price of around $33.50.
AIG continues to focus on paying back the U.S. Government, and recently reduced the U.S. Treasury’s stake below 50%. With a beta of 3.4, the volatility of this stock does present risks for investors despite its P/B ratio of 0.5, which is below the industry average of 0.8. Analysts are expecting current year EPS to come in much stronger than a year ago, with full year 2012 totals estimated to be $4.26, compared to 2011 EPS of $1.02.
Bank of America (NYSE: BAC), which accounts for 12% of Fairholme’s reported holdings, announced Q2 results with operating earnings of $0.17 per share, down from $0.33 the same quarter last year and $0.31 from the previous quarter. Bank of America did manage to increase its Tier 1 common equity ratio to 11.24% for Q2, up from 9.86% at the end of 2011. The company’s delinquency rates continue to be above its peers, but reserves now cover almost 2-times current annualized net-charge offs.
Citigroup (NYSE: C), like the previous two companies, trades at a historically low P/B, currently at 0.5. The company’s Q2 operating results came in at $1.00 per share, versus $1.07 a year ago and $0.95 last quarter. Consensus estimates were $0.89. Citi remains troubled with core revenue generation, posting revenue that was down 7% year over year, versus expenses that were only down 2%.
JPMorgan Chase (NYSE: JPM) and Wells Fargo (NYSE: WFC) have been two of the better performing financial stocks over the last five years, with JPMorgan down 13% and Wells Fargo only down 4%, while the other three names are all down over 80% over the five year period: AIG down 98%, Citi down 93% and Bank of America down 82%. Both JPMorgan and Wells Fargo also have industry high P/B ratios, JPMorgan at 1.2 and Wells at 1.4.
The industry has not fully recovered from the financial crisis. The Dow Jones U.S. Financials Index is down almost 50% over the past five years, while the Dow Jones Index is only down 2%; the financials index is up 21% year to date, versus the Dow Jones up only 11%.
Two of the more beaten down names have been AIG and Bank of America. Both trade at P/B ratios of around 0.5, which is below the industry average of 0.8, but both also have a much tougher road back. Nonetheless, these two companies should benefit from QE3 with a stabilizing of their balance sheets going forward. However, for those looking for a less risky entry into financials, they should consider JPMorgan or Wells Fargo, each paying a decent dividend at 3% and 2.5%, respectively.
Looking For More Analysis?
To learn more about the most-talked-about bank out there, check out the Fool’s in-depth company report on Bank of America. The report details Bank of America’s prospects, including three reasons to buy and three reasons to sell. Just click here to get access.
This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article.The Motley Fool owns shares of American International Group, Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: long JAN 2014 $25.00 calls on American International Group, short OCT 2012 $33.00 puts on Wells Fargo & Company, and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend American International Group and Wells Fargo & Company. 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.