Four Causes Huge Financial institution Shares are Headed for Extra Ache

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Shares of the 4 largest commercial lenders in the U.S. are trading at an average forward P/E ratio of just 9.4 times consensus estimates for 2020 earnings, about 11% below their average valuation during the past 5 years, per data from FactSet Research Systems reported by The Wall Street Journal. On the surface, these bank stocks appear to represent bargains for investors, but a number of problems are lurking in the background, including declining net interest margins, decelerating loan growth, and rising default rates on loans, the report notes.


The 4 banks in question are JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup Inc. (C), and Wells Fargo & Co. (WFC). The valuation discounts run from a slim 1% or so for JPMorgan Chase, which is widely viewed as among the best-run U.S. banks, to about 22% for Wells Fargo, which has been beset by problems and scandals, the Journal indicates.



Significance For Investors

The average net interest margin for the 4 banks is projected to rise by just 1 basis point in 2019, followed by a 4 basis point decline in 2020, bringing that average approximately to where it was in 2Q 2018, according to the consensus estimates compiled by FactSet and reported by the Journal. Should a recession or loosening by the Federal Reserve send interest rates lower, this margin is bound to fall yet more, the article observes.


Loan growth is expected to be a mere 0.8% in 2019, versus 2.2% in 2018. The estimates anticipate a rebound to 3.0% growth in 2020, which may not be realistic if the economy continues to slow.


Charges against earnings for bad loans are forecasted to rise from 0.55% of total loans in 2018 to 0.7% in 2019, bringing default rates back to 2014 levels. However, a protracted economic slowdown, let alone a recession, is bound to send default rates upward.


“Returns have likely peaked for most banks and positive catalysts for meaningful revenue growth are hard to find at this time,” as Brian Kleinhanzl, an analyst at investment banking firm Keefe, Bruyette & Woods (KBW), wrote in a research note quoted by Barron’s. “As a result of our macro assumptions, we believe that the return improvement story for Universal Banks is mostly over with only select banks seeing meaningful return improvement potential beyond 2019,” he added. Those select banks include Citigroup, Bank of America, Wells Fargo (WFC), and State Street Corp. (STT).



Looking Ahead

As the reporting season for 2Q 2019 gets underway, the financial sector is projected to be the top performer within the S&P 500 Index (SPX) in terms of earnings, with the consensus calling for 4.3% year-over-year (YOY) EPS growth, per data from S&P Capital IQ as reported by research firm CFRA. Analysts at CFRA expect solid 2Q 2019 results for big U.S. banks from fee-based businesses, such as credit cards, asset management, and wealth management. They anticipate loan growth among both consumers and commercial clients, and a boost from strong M&A and IPO activity.


Once 2Q 2019 results are in the books, however, the longer-term concerns mentioned above may come to the fore. This may be sooner than expected, should earnings reports disappoint.




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