U.S. bank stocks should double — eventually
Is now the time to buy U.S. bank stocks? Many are earning money, look well capitalized and have reported three straight quarters of declining loan losses. Yet the sell-off of the past six weeks has lopped up to a fifth off the value of large and regional players alike, pushing even strongholds such as JPMorgan back to book value or below. That ought to be a bargain.
Some investors certainly seem to think so. Bill Ackman recently bought 150 million shares of Citigroup. Appaloosa’s David Tepper likes Bank of America, as does renowned hedge fund manager John Paulson, who increased his stake in the Charlotte-based lender by 11 percent in the first quarter. He told his own investors late last year the stock could hit almost $30 a share — double where it is now.
That’s certainly possible for BofA, as well as some of its rivals. And pre-tax, pre-provision (PTPP) earnings — one of the metrics used to judge banks’ health in last year’s stress tests — would not even have to grow from current levels. What it would require is a drop in loan loss provisions. These appear to have peaked for the industry at around 3.5 percent of loans and could halve in the next year or so, according to Goldman Sachs. Its analysts also reckon industry-wide provisions could, within a couple of years, head below normal levels of around 0.75 percent of loans and stay there for three years, based on previous regional cycles.
Assume BofA, which trades at around three-quarters of book value, keeps raking in $14.5 billion in PTPP earnings, as it did last quarter. That’s $58 billion a year. If quarterly provisions halve to $4.9 billion and its tax rate stays at 27.3 percent, BofA’s annual net income would hit $28 billion. Pop that on a steady-state multiple of 10 times earnings, and BofA would be worth almost $28 a share, some 80 percent above where it currently trades. Were provisions to fall by three-quarters, then BofA could be worth, at almost $35 a share, even more than Paulson’s forecast doubling.
Run the same math for JPMorgan, and its stock could soar by 55 percent, to $60 a share, if provisions halve, and by 90 percent if they should fall by three-quarters. There’s less upside for PNC : its stock could rise between 10 percent and 40 percent based on these calculations. Profitable banks have other carrots to dangle, too: they’re likely to increase dividend payouts and restart buying back stock once lingering questions are answered about how much regulatory capital and how much of a liquidity pool they need. These may be resolved by the end of the year.
It’s a tougher call for the likes of Alabama-based Regions Financial or Atlanta’s SunTrust. Both lost money last quarter, and though they’d turn profitable if provisions fell by 75 percent, a simple 10-times earnings multiple wouldn’t even justify where they currently trade. These look more like restructuring plays. Revenue needs to grow and costs need to fall. Success could yield juicier rewards for shareholders, though: improving just enough to trade at book value, for example, would double returns for those buying Regions shares at their current price.
The trouble is markets are still jittery. The fall in many bank stocks of as much as 20 percent began right after the bevy of decent first-quarter earnings, accompanied by encouraging indications for the future, including lower loan losses. The uncertainty surrounding changes to financial regulation has weighed heavily, even though much of it is aimed at capital markets businesses that, as far as regional banks are concerned, contribute little or nothing to revenue.
Then there are continuing woes in the euro zone stemming from the Greek debt crisis. That has stoked fears the United States could be dragged down into a double-dip recession. Were that to happen, banks would face more, rather than fewer, loan losses and in some instances might even be forced to dilute shareholders by raising yet more capital.
Of course, unless the economy were to really tank, the strongest banks would still have the underlying earnings power to justify their stocks doubling — eventually. But the worry that any such gains may be further off than thought just two months ago appears to have made many investors wary.