Which Bank Stocks Should You Buy Now?

  • Valuations for bank stocks look fairly compelling, but its worth considering the downside risks before advancing on banks.
  • Of course, the worst case scenario seems fairly improbable, as broader market valuations look poised to recover.
  • Bank of America and JPMorgan Chase stocks present compelling value cases and have near-term upside to revenue.

For the most part, I’m a pretty huge fan of banks, due in part because sentiment around financial sector names has weakened quite considerably creating value opportunities. The downside scenarios seem extremely improbable given the backdrop of somewhat improving macro fundamentals with some of that mitigated due to currency volatility. Of course, the irony with banks is that earnings results are heavily market dependent, so if the stock market is doing really well, that too will be reflected in the earnings of big banks.

Generally speaking, trading revenue, market execution, asset management, investment bank underwriting does a lot better in an environment of rising stock prices. Of course, the impact on sales/earnings isn’t easy to model, but the vast majority of instances where banks report revenue surprises is due to the investment banking/trading/asset management component as opposed to consumer/commercial lending. Nonetheless, exposure to credit risk hasn’t been too significant despite the broad weakness in energy and production (E&P). While oil prices remain depressed due to structural issues, I believe big banks in general have enough diversification to withstand E&P charge-offs assuming oil prices do remain depressed. That being the case, the broader strength in consumer lending in conjunction with commercial and industrial loans, excluding oil, should exhibit some strength as we enter into the second half of the year.

Credit Suisse recently released a report in which they mention a stress tested scenario for FY’16. Of course this is the absolute worst case scenario assuming the economy tanks and net interest margins tighten considerably. Again, Morgan Stanley recently released a report that there’s approximately a 20% recession probability based on a model that captures leading economic indicators. Again, there’s not a very high probability of banks entering into a challenging economic environment over the immediate event horizon, but I’m going to cite some of the risks that Credit Suisse highlighted in their report.

According to Credit Suisse:

We liken our stressed scenario to a mild recession with NIMs narrowing, trading revenues declining and a move to prior peak CRE and C&I loss rates. There’s obviously significant earnings vulnerability; the resilience in book value with the group trading at just 1x book… that’s what’s more compelling. Otherwise stated, we believe that scenario to prove (i) manageable and (ii) at least partially discounted in the shares. Our stressed scenario… no benefit from Fed tightening, a 5% year-to-year decline in trading revenues, material incremental repositioning and legal charges, and materially higher credit costs (a 50bps increase in consumer credit losses combined with crisis peak losses for C&I and CRE loans).

Assuming all of those stress factors materialize, Credit Suisse anticipates an average 47% reduction in large banks earnings per share. Again, this seems fairly improbable, but it’s worth mentioning that the worst case is partially factored into the prevailing thought process of investors. Otherwise, there’s no way of rationalizing the depressed valuations in terms of earnings/sales/tangible book value. Furthermore, the assumptions presented by Credit Suisse anticipates both interest margins narrowing and declining trading revenues.

For the most part, I’m anticipating the stock market to recover due to mean reversion and some back-half improvement in earnings. As a result, I forecast the S&P 500 to trade at 2,221 by year end, which should positively affect bank earnings as IPO activity should increase in an environment of rising equity prices.

Best Bank Stocks Post The Latest Earnings Season?

I really like Bank of America (NYSE:BAC) and JP Morgan Chase (NYSE:JPM) coming out of Q1 earnings season. Both banks have managed their exposure to oil exploration and production better than some of the other banks. Bank of America has 2% exposure to oil whereas JPMorgan has 6% exposure. The impact on earnings has been minimal, and I anticipate that the charge-offs will moderately increase, but not to a devastating extent as we progress through the year. Furthermore, both banks are on pace to improve efficiency ratios and will directly benefit from an improving equity environment. As such, valuation, upside to investment banking, and expense management create compelling opportunities for both banks.

I will offer a more comprehensive dialogue on both banks in future articles. But, with Bank of America stock and JPMorgan Chase stock trading at a 12-month forward earnings multiple of 9 and 9.3 respectively, the value case is still fairly compelling. However, JPMorgan could struggle with prior year comps due to higher tax rate assumptions, but heightened corporate tax rates are already modeled into both buy side and sell side estimates. Therefore, I feel fairly confident that both these banks can sustain low to mid-teen EPS CAGR over the foreseeable three-year period. There is still room to improve on efficiency ratios, and estimates on sales seem fairly conservative among the analyst consensus. The upside to sales and earnings could lead to strong upside in the stock price, making these two banking stocks compelling buys.

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Author's Disclosures & Disclaimers:
  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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