4 Financials To Watch Closely In 2013
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Goldman Sachs (NYSE: GS), that money printing investment banker who was essentially a poster child for the sort of economic greed that led us into last decade's recession, has done a fine job since then of cleaning up its act. The same company that brought the investment atrocity of the Abacus scandal, and from whom a former employee wrote a well-received missive explaining how Goldman Sachs had lost its way, had apparently turned the page. After all, by the middle of 2012, CEO Blankstein was the new “darling of Wall Street” once it became apparent that JPMorgan Chase (JPM) and CEO Jaime Dimon had lost their way with the London Whale losses.
Adding to the growing affection for Goldman Sachs by midyear was news that it was voluntarily joining other Wall Street banks in complying with the Volcker Rule's restriction against proprietary trading as contained in the Dodd Frank financial reform package. It turns out, not so fast. You see, the Volcker Rule only applies to short-term trading, which, to management at Goldman Sachs, means less than sixty days. All through this period, continuing through today, Goldman Sachs has continued to trade vast sums of its money, both long and short positions, selling those interests after two or three months typically. I surely do not believe that this was intended by the Volcker Rule. These numbers from continued proprietary trading are not broken out separately on Goldman Sachs published reports, as if management knows the public ire that would otherwise result.
As some analysts happily point out, by some measures Goldman Sachs is undervalued today, despite trading at or near its 52-week high. Earnings have come off of 2011's dismal $4.51 and should be around $12 per share this year. If one is to believe the consensus of 38% annual profit growth, that number is predicated upon a basis of a really rough starting point for the company, 2011. Five year growth of 38% from that low point would equal about $19 per share by 2017, which is still substantially below what the mid $20 per share earnings it achieved in its best years. We all know the investment banking industry well enough to know that consistent profit growth is nearly impossible to achieve, given the highly cyclical nature of the industry. Goldman Sachs will never have a high price to earnings ratio. It is likely the best international investment bank to own, but the nature of the industry makes it unsuitable for most investors.
Bank of America (NYSE: BAC) displayed its continued retreat from the mortgage industry, announcing the sale of over $300 billion of mortgages it has been previously been servicing and collecting. Under Basel III rules, such mortgage assets are regarded as too risky an asset to assist in reaching capitalization levels. So, banks have an incentive to try to sell mortgage holdings, and non-banks have incentive to buy them. Specifically, Bank of America sold $215 billion of mortgages to Nationstar (NSM) for $1.3 billion and another $93 billion of mortgage holdings to Walter Investments (WAC) for $519 million. Bank of America plans to sell at least another $100 billion of mortgage loans within the next few weeks.
It is strange that Bank of America is worried at all about its capital levels, as at the close of the fourth quarter of 2012 its Basel III capital level should be approaching 9%, the highest of any of America's largest banks. Rather, Bank of America has had its fill with all things mortgages, courtesy of what has been termed among the worst acquisitions in history, Bank of America's 2008 purchase of Countrywide. Most of Bank of America's numerous billions in fines and other charges in recent years, including its recent $10.3 billion settlement, are traceable to that ill-timed and considered purchase.
Another antihero of the bank bailout era, American International Group (NYSE: AIG), came out with some curious news. After begging for and receiving some $182 billion in taxpayer aid, the largest amount of any single company last decade, it now has the temerity to consider suing the government that bailed AIG out, claiming the terms of the agreement it voluntarily entered into in 2008 amounted to a violation of the Fifth Amendment to the U.S. Constitution's prohibition against the taking of private property for public use, without just compensation. A suit was already brought by AIG's former CEO, Hank Greenberg, and he has demanded the new board of AIG consider joining the suit with him, on behalf of all shareholders. I will tell you, if AIG agrees to join the suit, I would not want to be representing that company in a hearing in the Senate Banking Committee with newly elected Warren on board.
Otherwise, AIG is doing quite well. Now that it is unencumbered by high cost government debt, it can focus on running its newly slimmed down business. AIG is more or less a pure insurance play now, assuming the sale of its aircraft leasing unit goes though as it should in the first half of 2013. But the fact is I worry about the future profitability of all large property casualty insurance carriers due to the impacts of climate change brought on by worldwide pollution run amok. And without the labyrinth of worldwide businesses that used to cushion core insurance earnings, AIG has become quite fully exposed to an increasingly unpredictable world. I doubt I will ever recommend this stock again.
What we find among larger financial institutions is confusion on many levels. There are smaller and simpler financial institutions that make far more sense to me. One such company I have my eye on right now is Pennsylvania's First Commonwealth Financial (NYSE: FCF). This $6 billion asset bank is on track for earnings this year of about $46 million, or $0.45 per share, tripling the total from 2011. But more than most other areas of the country, the mid Atlantic area is seeing solid loan growth, and First Commonwealth has been paying higher credit costs than most banks, and as longer term deposits reprice themselves at today's rates, those credit costs will plummet. The current year estimate provides a return on assets of just 0.75%. As revenues from loan growth and savings from credit costs kick in, I see First Commonwealth being able to get is return on assets up above 1.0% by 2014, with the stock price perhaps doubling from today's level. This smaller regional is not for the faint of heart, but has the potential to deliver excellent capital gains over the long run.
StockCroc1 has no position in any stocks mentioned. The Motley Fool recommends American International Group and Goldman Sachs Group. The Motley Fool owns shares of American International Group and Bank of America and has the following options: Long Jan 2014 $25 Calls on American International Group. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!