Financials Looking Better But Not Healed Yet

12/7/2015


In some ways, the prospects for financial stocks haven't looked so bright since before the 2008 meltdown. This year is on pace for the fewest U.S. bank failures since 2007. Net charge-offs for U.S. lenders declined 6% in the September quarter — the 21st consecutive quarterly decline.

Bank executives and investors eagerly await the Federal Reserve's interest-rate hike, which could come as soon as December. A rising-rate environment could make banks more profitable if they can raise the rates they charge for loans at a faster pace than what they pay out on deposits.

But plenty of problems still plague the sector.

Big fines

U.S. banks have paid more than $204 billion in fines through at least 175 settlements since 2009. That total will likely rise, considering 288 investigations and cases are still open.

Credit risk

Regulators are sounding the alarm about rising credit risk assumed by the banking sector. In November, the Federal Deposit Insurance Corp. (FDIC) warned that relaxed underwriting standards for automobile, energy, and multifamily loans could spark an outbreak of losses in coming years. The New York Fed added that auto lending has nearly reached 2006 levels, with many loans going to consumers with bad credit scores.

Banks are also struggling to sell loans issued to junk-rated companies amid weakening demand for the risky products. Declining values for these levered loans could weigh on banks' December-quarter earnings.

No government safety net

The Federal Reserve has proposed new rules that would force U.S. banks to raise billions of dollars in long-term debt that would be used to recapitalize them after another financial meltdown, rather than relying on a federal bailout. The debt requirements would give banks an extra cushion of liquidity to draw on. Wells Fargo ($55; WFC) says it would need to issue at least $40 billion in long-term debt to meet new U.S. rules.

These rules don't go into effect until 2022, allowing banks to raise the debt gradually. Global regulators have issued similar liquidity rules for the world's 30 largest banks. Citing the reduced likelihood of government aid in a crisis, ratings agency Standard & Poor's says it may cut its credit grades for eight large U.S. banks.

Compliance burdens

Banks grapple with compliance costs that consume a greater portion of their resources than they once did. The costs include safety checks to prevent money-laundering and the provision of data for regulators' stress tests. The combination of rising regulatory compliance costs and persistently low interest rates has put pressure on executives at smaller banks to improve efficiency. As a result, the industry could soon see a wave of mergers between regional banks.

For all the financial sector's problems, attractive spots still exist — after all, the S&P 1500 financial sector covers a broad universe of 14 different industries. In the tables below we identify the best and worst financial industries from four different angles. Note that averages exclude P/E ratios above 75 and changes in sales or earnings exceeding 75%.

EXPECTED PROFIT GROWTH
Est. EPS Change,
--------- Next Year ---------
% Of Stocks With
---- Rising Estimates ----
Industry (Number Of Companies)
Average
(%)
Rank
Average
(%)
Rank
Real estate management (4)
21
1
50
4
Diversified financial svcs. (11)
14
4
55
3
REITs (92)
15
3
42
5
Multiline insurance (8)
10
6
0
13
Reinsurance (5)
(5)
14
40
6
Diversified banks (6)
8
10
0
13
OPERATING MOMENTUM
-- 12-Month EPS Change --
12-Month Sales Change
Industry (Number Of Companies)
Average
(%)
Rank
Average
(%)
Rank
Thrifts & mortgage finance (14)
19
2
12
2
Diversified financial services (11)
16
3
8
4
REITs (92)
5
6
18
1
Diversified banks (6)
2
7
0
14
Reinsurance (5)
(13)
13
0
12
Multiline insurance (8)
(13)
14
0
13
VALUATION
---- Trailing P/E Ratio ----
P/E On Next Year's
--- Estimated Earnings ---
Industry (Number Of Companies)
Average
Rank
Average
Rank
Consumer finance (13)
12
2
10
1
Life & health insurance (11)
13
3
11
2
Reinsurance (5)
11
1
12
4
Diversified financial svcs. (11)
26
13
20
12
Real estate management (4)
25
12
25
13
REITs (92)
39
14
38
14
DIVIDEND
----- Dividend Yield -----
5-Year Annualized
----- Dividend Growth -----
Industry (Number Of Companies)
Average
(%)
Rank
Average
(%)
Rank
Diversified banks (6)
1.8
7
42
1
Life & health insurance (11)
1.9
6
34
2
Asset management (19)
2.3
3
23
6
Insurance brokers (5)
1.7
8
8
13
Real estate management (4)
0.2
14
21
7
Investment banking (12)
1.3
11
9
12

Attractive fishing holes for growth-oriented investors include real estate management, diversified financial services, and real estate investment trusts (REITs). Value investors should consider consumer-finance companies and insurers, while income investors may find the best dividend stocks among diversified banks, insurers, and asset managers.

Four of our favorite financial stocks are reviewed in the following paragraphs, and J.P. Morgan ($67; JPM) is profiled in Analysts' Choice.

Jones Lang LaSalle ($166; JLL) shares surged on the company's September-quarter results, as investors expressed relief that its somewhat volatile investment-management unit remains strong. Jones Lang receives incentive fees based on the performance of its real estate investments, which can vary widely from quarter to quarter.

Both per-share profits and sales have grown in 10 consecutive quarters, helped by a combination of organic growth and small acquisitions. In early December, Jones Lang agreed to buy CIB Management, a commercial-property manager based in Baltimore. Management also remains upbeat about the commercial real estate market, which could remain in its current upturn cycle for another two years. Rising analyst estimates call for 10% higher per-share profits in the December quarter on 8% sales growth. The stock earns a Quadrix Overall score of 95, supported by above-average ranks for all six Quadrix categories. It scores 90 or higher for both sector-specific ranks. Jones Lang LaSalle is a Focus List Buy and a Long-Term Buy.


Lincoln National ($55; LNC) provides annuities, life insurance, and retirement-planning services. Rising interest rates should help its business, as should the growing population of retirees, who typically prefer investment products that offer a steady stream of income. Shares have advanced since Lincoln posted September-quarter results. Reported earnings per share contracted 29%, largely due to legal expenses and a higher reserve assumption for its life insurance business. Underlying fundamentals appeared strong, as the annuities and group-protection units grew operating income at least 5%.

Lincoln also announced a 25% dividend hike, pushing its yield to 1.8%, which exceeds its five-year average of 1.1%. The dividend seems likely to keep rising at a brisk clip, given Lincoln's steady organic growth and conservative payout ratio; Lincoln returns just 13% of earnings through its dividend, while S&P 1500 life and health insurers average 22%. The consensus expects Lincoln's per-share profits to surge 19% in 2016, roughly double its industry-group average. Yet its shares trade at just eight times estimated 2016 earnings, a 26% discount to its industry average. Lincoln targets long-term profit growth of 8% to 10%. Lincoln is a Long-Term Buy.


U.S. Bancorp ($44; USB) is small by the standards of most S&P 1500 diversified banks, with its market value of $77 billion less than half of the industry average. But it comes up big on dividend yield (2.3%, versus the industry average of 1.8%) and expected growth for 2016 per-share profits (9%, versus 8%). U.S. Bancorp is also the sole S&P 1500 diversified bank with a net interest margin still above 3.0%. Net interest margin, a key profitability metric for banks, measures the spread between the interest paid on deposits and the interest charged for loans.

The stock's Quadrix scores aren't great, though its Overall rank has risen to 71 from 61 at the end of October. Over the first nine months of 2015, the bank countered rising expenses with loan growth and higher fees from credit and debit cards. Management says net interest margin has stabilized and expects modest loan growth to continue in coming quarters. U.S. Bancorp shares have returned 9% over the past three months and remain a Long-Term Buy.


Wells Fargo's ($55; WFC) per-share profits are on pace for unspectacular growth of 1% this year. But 2016 is projected to be the seventh year in the past eight with earnings growth in excess of 5%. In a difficult banking environment, Wells Fargo owes some of its success to convincing customers to sign up for multiple products and services. For instance, each household with a Wells Fargo retail-banking account uses six of the bank's products or services on average. But the bank's high-pressure sales culture has led to a pair of investigations into claims that employees used fraudulent tactics to cross-sell financial products, reported The Wall Street Journal.

So far, Wells Fargo has been spared the worst of the legal headaches lingering from the financial meltdown. It has made 10 separate settlements since 2009, with fines totaling $10.24 billion, reported CNBC. Three banks have spent more on settlements — Bank of America ($17; BAC), J.P. Morgan Chase ($67; JPM), and Citigroup ($54; C) have agreed to penalties amounting to a combined $135.60 billion, roughly two-thirds of U.S. bank fines. Wells Fargo yields 2.7% — higher than any other diversified bank in the S&P 1500 Index — and is a Long-Term Buy.

A-RATED FINANCIALS
We rate 11 financial stocks A (above average) on our Monitored List. Those on our buy lists are in bold.
12-Month
-- Change --
Est. EPS,
-- Next Year --
--- P/E Ratio ---
-------- Dividend --------
----- Quadrix Scores -----
Company
(Price; Ticker)
EPS
(%)
Sales
(%)
Change
(%)
90-Day
Trend
(%)
Trailing
Based
On Next
Year
Est.
Earnings
Yield
(%)
5-Year
Annual.
Growth
(%)
Payout
Ratio
Overall
12-
Factor
Sector
Reranked
Overall
Industry
Aflac ($66; AFL)
(5)
(8)
5
1
11
10
2.5
7
26
94
72
94
Life & health
insurance
American Express
($71; AXP)
2
(3)
3
(4)
13
13
1.6
8
21
77
90
86
Consumer
finance
Bank of America
($18; BAC)
(8)
(6)
10
(3)
13
11
1.1
38
15
78
96
82
Diversified
banks
CBRE ($37; CBG)
16
17
14
4
19
16
0.0
NA
0
95
95
88
Real estate
mgmt.
J.P. Morgan
Chase
($67; JPM)
11
(3)
7
(3)
12
11
2.6
52
32
83
84
87
Diversified
banks
Jones Lang
($166; JLL)
28
12
2
1
17
16
0.4
21
6
95
97
90
Real estate
mgmt.
Lincoln National
($55; LNC)
(17)
8
19
(2)
9
8
1.8
80
13
91
71
94
Life & health
insurance
MetLife
($51; MET)
(9)
(2)
19
(3)
10
8
2.9
14
30
66
74
80
Life & health
insurance
Travelers
($115; TRV)
8
(1)
(8)
2
10
12
2.1
11
22
98
96
97
Ppty./casualty
insurance
U.S. Bancorp
($44; USB)
2
2
9
(2)
14
13
2.3
38
32
71
48
68
Diversified
banks
Wells Fargo
($55; WFC)
1
3
7
(2)
13
12
2.7
49
36
75
73
75
Diversified
banks
Note: Quadrix scores are percentile ranks, with 100 the best.     NA Not available.

 


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