Bank stock winners and losers for 2014

By Philip van Doorn

Opinion: Two credit card lenders take the lead American Express U.S. banks may be nickeling-and-diming their customers, but they’ve been enriching their investors. The industry’s recovery from near-bankruptcy in late 2008 and early 2009 has been extraordinary. In recent years, the 24-member KBW Bank Index /quotes/zigman/21809808/realtime BKX +0.03%  rose 30% during 2012, as Bank of America Corp. /quotes/zigman/190927/delayed/quotes/nls/bac BAC +0.18%  led the way, more than doubling. The index’s gains accelerated last year as it surged by 35%, with regional banks charging ahead — KeyCorp /quotes/zigman/136057/delayed/quotes/nls/key KEY -0.07%  of Cleveland posted a 63% total return. The bull run has slowed to a walk this year, with the index up 2% through yesterday’s close, mirroring the broader S&P 500 Index. So where does that leave bank shares this year? So far, investors have been unimpressed with big banks’ capital plans, and several have pre-announced weak first-quarter trading revenue. And Citigroup Inc. /quotes/zigman/5065548/delayed/quotes/nls/c C +0.17%  had its annual capital plan rejected by the Federal Reserve for the second time in three years. /quotes/zigman/272085/delayed/quotes/nls/jpm JPM -0.25% Many of the largest banks have succumbed to even more cost-cutting, as historically low interest rates, slowing mortgage refinancing and stricter standards erode their loan businesses. They’ve also deployed excess capital mainly through stock buybacks, although some, including Wells Fargo /quotes/zigman/239557/delayed/quotes/nls/wfc WFC +0.35% , have issued so many new shares for employee compensation that their share counts have been largely unchanged. First Niagara Financial Group Inc. /quotes/zigman/89963/delayed/quotes/nls/fnfg FNFG -2.77%  of Buffalo has been the weakest performer among the 24 stocks, down 12% this year. The bank in January announced a major change in strategy, as it has been suffering indigestion from a multiyear acquisition spree. First Niagara has undertaken an ambitious program to improve its technology and operating performance, which will mean high expenses and mediocre earnings until at least 2018. That’s an eternity for many investors. With big banks undergoing big changes — regulatory reviews, rising rates, compensation backlash and harsh capital-plan reviews, among others — what follows is a breakdown of those that look stressed and depressed, along with two that impressed. We’ll call them the winners and losers of 2014. Stressed Citigroup, whose shares are down 11% this year, is the second-worst performer among the 24 components of the KBW Bank Index this year. Citi’s also the cheapest among large-cap bank stocks, trading for only 0.9 times tangible book value and 8.3 times the consensus 2015 earnings estimate ($5.58, in this case) among analysts polled by FactSet. Citigroup’s 2014 capital plan was rejected by the Federal Reserve late last month on “qualitative” grounds, and the Fed made clear its disappointment, saying the bank had failed to address some of the “deficiencies in its capital planning process” that had previously been identified by bank examiners. That was the second time in three years that Citi’s capital plan was dismissed as inadequate, and the company will have a tall order convincing the Fed to allow significant deployment of excess capital through dividend increases or share buybacks. That is especially troubling for Citigroup’s long-term investors, whose holdings have been diluted dramatically since the industry’s government bailouts began in 2008. Citi’s excess capital continues to grow, meaning its return on equity will suffer. Short-term investors will rightly steer clear of the stock. And there won’t be a reduction in share count to help boost earnings per share. Sell-side analysts who have pumped Citi’s shares for years recently have been silent. Sterne Agee analyst Todd Hagerman on Thursday downgraded Citi to “market perform” from “outperform,” while lowering his price target for the shares to $52 from $61, citing the “subdued prospects for any meaningful capital return in ’15,” as well as slowing earnings growth. Citi is unique among large-cap U.S. banks in that it derives most of its revenue and earnings from operations outside North America. But this year’s stress tests included a new element, the “global market shock,” which was especially difficult for the bank. With regulators now bent on forcing the company to simplify its business, and the recent fraud in its Banamex subsidiary in Mexico throwing another monkey wrench into the works, investors can expect plenty of additional restructuring ahead. Factoring in the dilution of Citi’s shares from common-equity raises following its $45 billion bailout in 2008 and from the conversion of part of the government’s preferred stake in the company to common shares, as well as the reverse 1-for-10 split the shares underwent in 2011, the stock’s 10-year total return is a negative 89%. That is, by far, the worst performance of any large-cap U.S. bank. Zions Bancorporation /quotes/zigman/80277/delayed/quotes/nls/zion ZION +0.02%  of Salt Lake City also had its 2014 capital plan rejected by the Fed, one week after the bank failed the initial round of stress tests. Zions was the only bank to fail the stress tests and have its capital plan rejected on quantitative grounds, since its minimum Tier 1 common equity ratio through the regulator’s nine-quarter “severely adverse” scenario was just 3.6%, far shy of the required 5% for a well-capitalized bank. Zions submitted a capital plan that included a common-equity raise of $400 million. According to the Federal Reserve, that capital increase would only have brought the bank’s minimum Tier 1 common equity ratio through the severely adverse test scenario to 4.4%. The bank will submit a revised capital plan by the end of this month, presumably bumping up the common equity to a level the Federal Reserve finds acceptable. Meanwhile, the prospect of a significant dilution of the shares hasn’t kept the stock from rising. Shares of Zions are up 3% this year. Depressed Investors are already bracing for a disappointing round of first-quarter earnings reports from the largest banks. J.P. Morgan Chase /quotes/zigman/272085/delayed/quotes/nls/jpm JPM -0.25% , at its investor conference in February, said first-quarter trading was running at a pace 15% below that of a year earlier. That led to a steady stream of earnings-estimate cuts for 2014 from sell-side analysts for not only J.P. Morgan, but also Bank of America and Citigroup. Bank of America will see most of its first-quarter earnings wiped out by its March 26 settlement with Fannie Mae /quotes/zigman/226360/delayed/quotes/nls/fnma FNMA +3.57%   and Freddie Mac /quotes/zigman/226335/delayed/quotes/nls/fmcc FMCC +3.56% . The bank has agreed to pay the government-sponsored mortgage enterprises $6.3 billion in cash, and also to repurchase at fair value residential mortgage-backed securities with a value of $3.2 billion. With much of the settlement being covered by the bank’s litigation reserves, Bank of America’s first-quarter pre-tax earnings will be lowered by roughly $3.7 billion, or 21 cents a share, after tax. The good news for shareholders is that the settlement resolves “all securities law and fraud claims” against Bank of America and its subsidiaries by the GSEs and their regulator, the Federal Housing Finance Agency. The recent news for Bank of America has been decidedly mixed. The bank came through the first round of stress tests on March 26 with a minimum Tier 1 common equity ratio of 5.9%, the lowest for any stress-tested bank except for Zions Bancorporation. Before the capital plan reviews were completed by the Federal Reserve the following week, Bank of America took a mulligan and lowered its requested capital deployment, according to the regulator. Under its original capital plan, the bank would have had a minimum Tier 1 common equity ratio of just 5.0% through the severely adverse scenario. Under its revised plan, which includes an increase in the quarterly dividend to 5 cents from 1 cent and $4 billion in common-share buybacks from the second quarter of 2014 through the first quarter of 2015, Bank of America’s minimum Tier 1 common equity ratio through the severely adverse scenario would be 5.3%. Bank of America managed to reduce its common-share count by 2.1% during 2013, according to FactSet, with buybacks totaling $3.2 billion. Despite a lower-than-expected capital return and the major settlement with the GSEs, investors have sent the bank’s shares up 5% this year. There’s no denying that what’s good for the United States is good for Bank of America, and the stock has led the recovery among big names as the economy has recovered. But there’s also no denying that the bank’s earnings performance has been underwhelming, with a 2013 return on average assets (ROA) of 0.52% and a return on common equity (ROCE) of just 4.61%, according to FactSet. Impressed If we confine ourselves to the 23 publicly traded U.S. banks subject to the Fed’s stress tests and capital-plan reviews, the biggest winners are Discover Financial Services /quotes/zigman/470130/delayed/quotes/nls/dfs DFS -0.44%  and American Express Co. /quotes/zigman/217470/delayed/quotes/nls/axp AXP -0.13% . You might not regard American Express as a bank, but the company files financial statements with the Federal Reserve as a bank holding company and is a significant lender, in addition to its traditional charge-card and payment-processing focus. Those companies combine strong earnings performance, growth in earnings and loans, and in the case of Discover, a low stock valuation for such a strong company. Discover managed to lower its share count by 7% in 2012 and 4% in 2013. The company received Federal Reserve approval for up to $1.6 billion in buybacks from the second quarter of 2014 through the first quarter of 2015. That’s down from the $2.4 billion stock-repurchase plan that was approved a year earlier, but it’s a reasonably safe bet the bank will continue reducing its share count. The company also plans to raise its quarterly dividend to 24 cents a share from 20 cents. Discover achieved a strong return on common equity of 24.8% last year, down from 26.6% in 2012. During 2013, the company’s earnings grew to $602 million, or $1.23 a share, from $539 million, or $1.06 a share, in 2012. The company also grew its loan receivables by 5% year-over-year to $66.8 billion as of Dec. 31, which was no mean feat as U.S. consumers continued to deleverage. The icing on the cake for Discover is a low valuation: The shares trade for only 10.2 times the consensus 2015 EPS estimate of $5.54. While it’s not a fair comparison, Bank of America’s stock also traded at a forward price-to-earnings ratio of 10.2, based on a consensus 2015 EPS estimate of $1.61. And Bank of America’s ROCE is a whole lot less impressive than Discover’s. American Express reduced its share count by 3.5% during 2013, after lowering the count by nearly 6% in 2012. The company received approval from the Fed for up to $4.4 billion in common-share repurchases during 2013, and another $1 billion in buybacks during the first quarter of 2015, and also to raise its quarterly dividend to 24 cents from 23 cents. That total of $5.4 billion is up from the approved repurchases of $3.2 billion announced a year earlier. American Express achieved a stellar return on common equity of 27.7% during 2013, up from 23.5% the previous year. The company grew its earnings by 20% to $5.36 billion in 2013 from $4.48 billion in 2012, and grew its earnings per share by 25% to $4.88 in 2013 from $3.89 in 2012. American Express card member loans were up 3% year-over-year to $66.0 billion. Over the past 10 years, American Express’ return on common equity has only dipped below 20% once, in 2009, when it was 13.78%, and the ROCE has dropped below 25% only twice. That sort of success has its price, and the shares trade for 14.3 times the consensus 2015 EPS estimate of $6.05. That forward P/E multiple is higher than Discover’s, and it is higher than most large U.S. banks’, but it may also be a bargain, considering the company’s outsized earnings performance year after year.

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