“2012 is showing signs of repeating 2011,” with a summer slowdown following a strong first quarter for bank stocks, according to Goldman Sachs analyst Richard Ramsden.
Goldman on Thursday cut its price targets for 18 out of 19 large U.S. lenders, with the exception of American Express (AXP). Analyst Ryan Nash maintained his “Buy” rating on Amex, while keeping his price target for the shares at $16, while lowering his 2012 earnings estimate by a nickel to $4.35 a share and also cutting his 2013 EPS estimate by five cents to $4.90.
Nash estimates that American Express will achieve a very strong return on tangible of common equity in the range of 25% during 2012.
Ramsden said that “European concerns and a slowdown in the US recovery are driving lower capital markets activity and a resizing of earnings expectations,” and that Goldman was expecting “lower rates and a flatter curve to weigh incrementally as limited reinvestment options and loan yield pressure continues.”
With 10-year U.S. Treasury bond yields moving below 1.5% late last week, or “the lowest level in 60 years,” and with “the yield curve flattening,” Goldman Sachs sees net interest margin (NIM) “pressure beyond prior expectations,” and companies “most exposed include banks with longer duration fixed-rate assets, concentrations in mortgage-products, or large securities portfolios.”
Yields on newly produced loans and new securities investments “imply considerable downside to net interest margins,” according to Goldman, which estimated an average new loan yield of 3.75% among the lenders in its coverage universe, “if we stay in the current rate environment for another three years,” declining from 4.81% during the first quarter.
There is still “some room to lower funding costs,” for 13 of the banks covered in the Goldman report, with KeyCorp (KEY), BB&T (BBT), and Fifth Third Bancorp (FITB) seen as “best positioned” to lower their cost for deposits and borrowings over the next year, as time deposits re-price and trust preferred shares are redeemed.
- According to Nash, KeyCorp’s cost of funds declined to 0.77% during the first quarter, from 0.93% a year earlier, with total additional “potential savings” over the next year of 38 basis points from deposit re-pricing and the redemption of $1.2 billion in trust preferred securities. KeyCorp’s shares closed at $7.13 Wednesday, down 6% year-to-date, following a decline of 12% during 2011. Nash has a neutral rating on KeyCorp, and on Thursday lowered his price target for the shares to $8.00 from $8.50, while cutting his 2012 and 2013 EPS estimates by two cents, to 75 cents for both years.
- BB&T’s funding cost declined to 0.82% during the first quarter, from 1.16% a year earlier, according to Nash. A relatively low 17% of the company’s funding came from non-interest bearing deposits, compared to 27% for KeyCorp. Nash estimates that BB&T’s funding cost could come down 29 basis points over the next year, through deposit re-pricing and trust-preferred redemptions. BB&T’s shares closed at $28.39 Wednesday, returning 14% year-to-date, following a 2% decline during 2011. Based on a quarterly payout of 20 cents, the shares have a dividend yield of 2.82%. Nash rates BB&T a “Buy,” but cut his price target for the shares by two dollars to $35, while raising his 2012 EPS estimate by three cents to $2.89, and cutting his 2013 EPS estimate to $3.18 from $3.26
- Fifth Third Bancorp’s cost of funds declined to 0.58% during the first quarter, from 0.77% during the first quarter of 2011. Like KeyCorp, 27% of the company’s first-quarter funding came from non-interest bearing deposits. Nash estimates the company could see an additional decline in funding costs over the next year of 29 basis points, from deposit re-pricing and the redemption of trust preferred shares. Nash rates Fifth Third a “Buy.” The analyst cut his price target for the shares by a dollar to $15, while maintaining his 2012 EPS estimate of $1.50, and lowering his 2013 EPS estimate to $1.46 from $1.55.
Over the past two years, the largest U.S. banks have seen a continued boost to quarterly earnings from the release of loan loss reserves. Goldman Sachs sees “an increasing likelihood that the pace of credit improvement could slow or banks take a more cautious approach to provisioning,” so that “the releasing of excess loan loss reserves may slow and accordingly, the benefit to the bottom line will tail off.”
Bank of America’s (BAC) allowance for loan and lease losses declined by $1.6 billion during the first quarter, according to data provided by Thomson Reuters Bank Insight.
One measure of loan loss reserve adequacy is the ratio of reserves to total loans, which Ramsden estimates will decline for Bank of America from 3.16% at the end of this year, to 2.64% at the end of 2013. With such a large potential benefit from continued reserve releases, Bank of America is among the banks “most at risk” if the pace of credit quality improvement slows.
Bank of America’s shares closed at $7.64 Wednesday, returning 38% year-to-date after dropping 58% last year. Ramsden has a neutral rating on the company, and on Thursday lowered his price target for the shares to $8.00 from $8.50, while cutting his 2012 EPS estimate to 55 cents from 60 cents, and his 2013 estimate to 95 cents from a dollar.
On a brighter note, Ramsden said that Goldman was expecting “low rates to remain supportive of strength in mortgage banking, as banks profit from refinancing of homeowners’ mortgages.” With “mortgage rates hitting another low, we are entering in the fourth refinance cycle since the beginning of 2009,” and the “current cycle is projected to last through 3Q12 with four-quarter cumulative refinance volume estimated to surpass $1 trillion dollars in aggregate, per the Mortgage Bankers Association.”
Ramsden said that “high-margin HARP refinances comprise a meaningful portfolio of overall volumes.” HARP is the Home Affordable Refinance Program, which was expanded by President Obama early this year, to allow borrowers with first-lien residential mortgage loans held by Fannie Mae (FNMA) orFreddie Mac (FMCC) to refinance their full loan balances no matter how much the market value of the collateral property has declined. The expanded HARP is known as “HARP 2.0.”
Ramsden said that among banks covered by Goldman, Wells Fargo (WFC) “is expected to see the biggest direct benefit as 17% of its revenues in 1Q12 were mortgage related.”
With HARP accounting for 15% of Wells Fargo’s total mortgage loan originations during the first quarter, the analyst said that “We’re just beginning to see the results of HARP 2.0 start to kick in.”
Wells Fargo’s shares closed at $30.97 Wednesday, returning 14% year-to-date, following a 10% decline during 2011. Based on a 22-cent quarterly payout, the shares have a dividend yield of 2.84%. Ramsden rates Wells Fargo a “Buy,” and on Thursday lowered his price target for the shares to $37 from $41, while cutting his 2012 EPS estimate by five cents to $3.35, and his 2013 EPS estimate by 10 cents to $3.65.