Financials Had Time To Adjust

3/2/2015


Financial stocks are particularly sensitive to changes in interest rates.

Both insurers and banks tend to hold fixed-income securities on their balance sheets. Higher rates drive down the prices of most bonds, so financial companies could initially see a decline in the market value of their assets. But they will be eventually able to replace maturing lower-interest bonds with new, higher-yielding bonds, presumably boosting returns.

HISTORICAL RETURNS
The S&P 1500 Financial Sector has gotten off to a slow start after three years of outperformance.
----- Total Returns -----
Financial
Rank Among
10 S&P 1500
Sectors
Year
S&P 1500
Financial
Sector
(%)
S&P 1500
Index
(%)
2015*
(1)
2
9
2014
15
13
5
2013
34
33
4
2012
27
16
1
2011
(15)
2
10
2010
13
16
7
2009
16
27
7
2008
(52)
(37)
10
2007
(18)
5
10
2006
19
15
5
* Through Feb. 24.

The Federal Reserve seems to have telegraphed its intentions, even if the date of the first rate hike remains in question. Financial companies have had time to position their balance sheets to take advantage of the higher interest rates once they arrive. However, they haven't all prepared in the same way, and nobody knows exactly how the rate hikes will progress, so predicting stocks' reaction is risky.

Life insurers could face more headwinds than casualty and property insurers. First, life insurers are more likely to invest in long-term bonds, which tend to react more sharply to interest-rate changes than short-term bonds. Second, rising rates may drive policyholders to withdraw the cash value of their policies in order to seek higher returns elsewhere. However, a gradual rise in rates could generate more investor interest in annuities.

A stronger economy should improve demand for such bank products as consumer loans, credit lines, and advice regarding mergers and acquisitions. Banks also generate much of their profits from the spread between the interest they pay on deposits and the interest they charge for loans, known as net interest margin.

As the Fed raises rates, banks may be able to increase rates charged to borrowers more than the rates they pay out for deposits. In general, a gradual increase in interest rates should improve banks' profitability.

SURVEYING THE FINANCIAL LANDSCAPE
The S&P 1500 financial sector looks much like the broader index based on valuation and profit-growth prospects. Within the sector, life and health insurers stand out for value, REITs for dividend yield, and investment banks for estimated profit growth. All numbers except the stock count are averages.
Stock-
Market
Value
($Mil.)
-- Dividend --
--- P/E Ratio ---
12-Month
-- Growth --
Est.
Profit
Growth,
Next 12
Months
(%)
Quadrix Scores
Group (No. Of Stocks)
Yield
(%)
3-Year
Annual.
Growth
(%)
Trailing
12 Mos.
Next 12
Months,
Est.
Per-
Share
Profits
(%)
Sales
(%)
Value
Overall
Diversified
Banks (6)
158,679
1.7
29
19
12
3
(2)
4
80
62
Regional
Banks (74)
4,229
2.4
29
16
15
9
6
7
71
64
Asset Mgmt.
(18)
16,949
2.0
17
19
18
15
8
8
59
71
Invest.
Banking (13)
17,679
2.4
8
21
18
17
7
17
63
64
Consumer
Finance (13)
13,697
1.2
37
11
12
0
6
(6)
81
66
Divers. Fin'l
Svcs. (10)
50,729
1.3
26
27
24
7
10
13
36
68
Insurance
Brokers (5)
14,725
1.9
8
21
18
17
16
10
57
56
Life & Health
Ins. (10)
17,845
1.9
25
11
11
(4)
5
3
83
71
Multi-line
Insurance (9)
14,957
1.6
18
17
12
(10)
1
7
87
67
Ppty. & Cas.
Ins. (27)
7,457
2.1
18
15
14
13
6
5
76
73
Reinsurance (5)
5,524
1.7
16
9
12
18
4
(23)
83
85
REITs (90)
7,843
3.9
12
41
40
10
12
7
30
46
Real Estate
Mgmt. (4)
5,412
0.4
17
25
26
21
18
11
53
66
Thrifts & Mtg.
Fin. (13)
2,040
3.5
8
18
16
9
3
(3)
62
59
S&P 1500
Financials (297)
12,980
2.7
19
23
22
9
8
6
57
60
S&P 1500
avg. (1,500)
15,061
1.9
14
22
21
7
8
6
55
59
Note: Quadrix scores are percentile ranks, with 100 the best.

Of course, in addition to the absolute level of interest rates, investors should pay attention to the spread between short- and long-term rates. The Treasury yield curve has flattened over the last year, which means the spread between the yield of long-term bonds and short-term bonds has narrowed. With short-term rates pegged near zero for more than six years, the yield curve has behaved oddly, so investors — and financial firms — may have trouble predicting how the curve will behave once short-term rates begin rising.

Below, we review three financial stocks in more depth.

Ameriprise Financial's ($135; AMP) mutual-funds business is tied to the direction of the stock market and could be vulnerable if interest rates rise. But its annuities seem positioned to benefit from a gradual increase in rates. The company also has more than $20 billion in cash sitting in client brokerage accounts, earning a meager 0.2% interest. Even a modest bump in rates could offer upside to 2015 earnings targets.

The majority of asset managers in the S&P 1500 Index have seen their 2015 profit estimates decline in the past 30 days. However, analysts are ratcheting up estimates for Ameriprise, with the consensus projecting 15% higher earnings per share in 2015, nearly doubling the industry average of 8% growth. Yet the stock trades at 16 times trailing earnings, an 18% discount to its peer-group average.
Yielding 1.7%, Ameriprise tends to increase its quarterly dividend at the same time it reports March-quarter results. Ameriprise, scheduled to release results on April 22, is a Focus List Buy and a Long-Term Buy.


Lincoln National ($58; LNC) offers a bevy of annuities, life insurance, and retirement-planning services. Even relative to other life insurers, Lincoln is highly exposed to interest rates. A gradual increase in rates should strengthen Lincoln's fixed-annuities business, but a large portfolio of variable annuities could erode the company's earnings and balance sheet when rates rise.

Lincoln's Quadrix Overall rank of 99 reflects above-average scores for all six Quadrix categories. Both the Value and Momentum scores rank in the top 15% of our research universe. Sales jumped 13% last year, with growth accelerating in the second half. Yet the stock trades at just nine times estimated year-ahead earnings, 15% below the average for S&P 1500 life insurers. Lincoln is a Long-Term Buy.


Travelers' ($107; TRV) revenue rose for the sixth straight year in 2014, climbing 4% to mark the strongest annual gain since 2005. Full-year per-share profits increased 12%, as Travelers posted its highest gross profit margins since 2007. However, the average price hike for renewals continued to decelerate in the December quarter, suggesting Travelers may be pressed to expand profit margins further. Complicating matters, investment income could decline by $20 million each quarter this year as Travelers replaces maturing bonds with lower-yielding securities.

Despite these concerns, the stock looks unduly cheap. Travelers earns a Value rank of 92, well ahead of the average of 79 for S&P 1500 property and casualty insurers. At 10 times trailing earnings, the stock trades 7% below its five-year average and 31% below its peer-group average. Like Ameriprise, Travelers usually raises its quarterly dividend when announcing March-quarter results, typically in the second half of April. With a dividend yield of 2.1% and five-year annualized dividend growth of 12%, Travelers is a Buy and a Long-Term Buy.

TOP FINANCIAL STOCKS
Forecasts recommendations are presented in green, with those recommended by our sister publication Upside in bold.
Stock-
Market
Value
($Mil.)
------ Dividend ------
--- P/E Ratio ---
Profit Growth
12-Mo.
Total
Return
(%)
----- Quadrix Scores -----
Company
(Price; Ticker)
Yield
(%)
3-Year
Annual.
Growth
(%)
Payout
Ratio
(%0
Trailing
Forward
Last 12
Months
(%)
Next 12
Months
(%)
Overall
12-
Factor
Sector
Reranked
Overall
S&P 1500
Industry
Ameriprise Fin'l
($135; AMP)
25,873
1.7
37
27
16
14
25
15
28
98
91
97
Asset Mgmt.
AMERISAFE
($43; AMSF)
815
1.1
NA
17
15
13
52
13
15
95
97
97
Ppty./Cas.
Ins.
AmTrust Fin'l
($54; AFSI)
4,385
1.8
39
17
9
10
NA
(4)
53
100
100
100
Ppty./Cas.
Ins.
DuPont Fabros
($32; DFT)
2,103
5.3
39
139
26
29
28
(10)
28
55
67
47
REITs
J.P. Morgan
($61; JPM)
230,204
2.6
25
29
11
11
(4)
4
10
74
87
82
Divers.
Banks
Jones Lang
($163; JLL)
7,387
0.3
17
6
19
18
38
4
33
96
94
88
Real Est.
Mgt.
Lincoln National
($58; LNC)
15,324
1.4
47
13
10
9
25
4
18
99
80
99
Life/Health
Ins.
Navigators
($74; NAVG)
1,083
0.0
NA
NA
13
13
16
2
22
93
95
95
Ppty./Cas.
Ins.
Travelers
($107; TRV)
35,387
2.1
11
21
10
11
12
(10)
31
98
96
98
Ppty./Cas.
Ins.
U.S. Bancorp
($45; USB)
80,533
2.2
31
32
15
14
5
6
12
75
42
69
Divers.
Banks
Wells Fargo
($55; WFC)
292,098
2.5
41
35
14
13
5
4
23
73
70
71
Divers.
Banks
Western Alliance
($29; WAL)
2,509
0.0
NA
NA
17
15
27
11
27
96
54
88
Region.
Banks
Note: Quadrix scores are percentile ranks, with 100 the best.     NA Not available.

 


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