These Two Banks Lack Catalysts For Future Growth

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The earnings season is starting to gain some steam. Two big banks, Wells Fargo (NYSE: WFC) and JPMorgan (NYSE: JPM), have already presented their quarterly reports. As money is the blood of every industry, their reports are of interest for every investor, whether he considers buying of one these stocks or is interested in other industries.

Both banks have routinely beaten analysts’ estimates, both on earnings and on revenue. The investors’ reaction was subdued. Wells Fargo rose 1.77% on the day of the report, while JPMorgan lost 0.31%. As Wells Fargo and JPMorgan are up 26.6% and 27.6%, respectively, is this a sign that a pullback is around the corner?

Rising mortgage rates

The recent trend that banks can’t ignore is a rise of mortgage rates, which have recently reached their highest levels in 2 years. The 30-year mortgage rate was around 3.50% back at the end of April--now, it’s higher than 4.50% and continues to climb.

Wells Fargo has stated that one-third of its mortgage originations comes from new mortgages, while the other two-thirds come from refinancing. This is a very important fact, because as the rates rise, fewer and fewer people would consider refinancing their mortgages. Both Wells Fargo and JPMorgan estimate that if the current rate environment continues, they would see a 30% to 40% decline in mortgage applications.

During the earnings calls, two CEOs have had different views about the situation. Wells Fargo’s John Stump has stated that he does not manage the company for a specific rate environment, adding that while some parts of the company would do worse because of the rising rates, others would gain. Jamie Dimon, the CEO of JPMorgan, has stated that there would be a dramatic reduction in profits if the rates continue to rise.

Margins and growth

The quarter continued the margin trend for Wells Fargo. Net interest margin fell two basis points to 3.46%. The source of the decline was the growth in deposits. JPMorgan also saw a rise in deposits, which totaled $432.8 billion, up 3% from the last quarter. JPMorgan’s net interest margin dropped from 2.83% in the previous quarter to 2.60%.

While you can see that the margins have been cut down, the growing volume on almost every business front has helped the banks to see good profits. As retail investors start to come back to the market, brokerage and asset management products have thrived.

It typically happens that retail investors need a rising market to become more active. The market performance has been good so far, but the future of the continuing inflow of money depends on the market results.

Is it going to continue?

Would the banks continue to deliver profits as clockwork like they have been doing for a while? This question interests not only shareholders of the abovementioned stocks, but also shareholder of banks that are still due to report, like Bank of America (NYSE: BAC). The company, whose stock is up 19% so far this year, faces the same environment of rising rates. Given investors’ reaction to both Wells Fargo and JPMorgan’s reports, it’s safe to say that if you do not have a position in Bank of America, you’d better wait for the report to come out.

As mortgages are a sizable part of bank’s business, the future rates are important for their outlook. I do not see rates falling if the economy does not significantly slow down, and recent data is against this assumption. The Fed is unlikely to print more money either. In fact, it is likely to reduce its bond purchasing program when it finally sees that economy can go on its own. At some point of time, they would stop the purchases. They can’t last forever, and that should be taken into account.

Bottom Line

Bank stocks have had a good year, but now they can be struggling with a catalyst for future growth. JPMorgan is a little undervalued with a 9.2 forward P/E, while Wells Fargo trades at a 10.9 forward P/E and Bank of America trades at a 10.5 forward P/E.

Analysts’ target prices reflect the thesis that the banks are fairly valued. Wells Fargo and Bank of America are trading in the whereabouts of target prices, while JPMorgan still has a 5.6% upside if judged by mean analyst target price.

On the income front, Wells Fargo yields 2.40% while JPMorgan yields 2.80%. Bank of America is an outsider with a 0.30% yield. I do not expect stellar performance from any of these stocks. Positive growth that is likely to come from the asset management side would be likely offset by the decline in mortgage origination. The banks’ performance in the recent quarter was strong, but they need even stronger performance to continue the rise. I don’t see this coming in the near term.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase & Co., and Wells Fargo. 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!

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