By David Benoit
Profits at U.S. banks are tumbling, their stocks are
underperforming and their executives sound grim. Their long-term
investors are thrilled.
Value investors seek underappreciated companies, and they have
spent a decade betting that the banks are stronger than they were
going into the 2008 financial crisis. The market hasn't agreed.
While bank share prices were rallying through last year, sometimes
hitting record highs, they were broadly unloved.
Compared with the overall market, bank stocks have traded at
lower multiples of earnings and value since the financial crisis.
They have been punished as if investors expect any economic trouble
to expose underlying problems.
The solution, some investors believed, would be a new crisis to
prove the banks can survive, in a more convincing fashion than
annual practice stress tests have.
Enter the coronavirus pandemic.
No investor wished for a global pandemic, but the economic
response to slow the spread of the virus looks like a
laboratory-designed exercise to test bank survivability. The
Federal Reserve slashed interest rates and has said it expects to
keep them there for the next two years, which will hurt banks'
lending margins. Businesses and consumers are stressed, meaning
outstanding loans look riskier. Executives have warned the outlook
is bleak.
Bank stocks have plunged since the coronavirus hit. Still, the
bank bulls point to signs of strength inside the second-quarter
numbers. Quarterly profits were down almost across the board, for
example, but they say the fact there was any profit at all is
hopeful.
"If banks perform well in this crisis, it should inform the
perception of their stability," said Matthew Reed, portfolio
manager for Fidelity Investments' Select Financial Services and
Select Banking funds. "That's hard to prove out in good times."
The bank bulls' strategy runs counter to that of the many
investors piling into stocks like Amazon.com Inc., Netflix Inc.,
Apple Inc. and Microsoft Corp.
The market rally since March has been driven by those tech
growth stocks, particularly companies that seem to benefit from
social distancing and stay-at-home orders.
At the same time, industries exposed to general economic growth,
including banks and industrial companies, have been crushed. It is
harder to judge the earnings power of those types of companies
until investors get more clarity on the economy.
Those betting on banks have a different view: The banks, and
particularly the big ones, have piled up so much capital and
expanded their already-dominant positions since the last crisis
that they are more immune to an economic collapse than before.
These investors expect some pain but they think the market has
overreacted, especially since they believe bank stocks were already
undervalued before the coronavirus.
Banks and their investors point out that so far the banks have
continued lending and eased the economic burden for borrowers --
unlike the financial crisis, when they froze activity to preserve
their own health. Randal Quarles, the Fed's vice chairman, credited
their increased strength in a July speech for helping the
government and regulators.
"This has allowed the banking system to absorb rather than
amplify the current macroeconomic shock," Mr. Quarles said.
Investors and analysts admit there is still much uncertainty
about the pandemic, but they are betting on sizable gains to come
in bank shares.
Analysts at Oppenheimer & Co., for instance, say the
earnings multiples of Citigroup Inc. and Wells Fargo & Co.,
which have fallen sharply, suggest their stocks could double by the
end of 2022. JPMorgan Chase & Co., Bank of America Corp. and
Goldman Sachs Group Inc. could each rise some 50%.
For now, the crisis is still testing their bullish patience.
As U.S. companies tally the damage of the second quarter, banks
are proving among the worst performers. The 18 banks in the S&P
500 index posted a median 77% decline in earnings-per-share from
the prior year, according to FactSet. Analysts expect the entire
S&P 500 index to post a 38% decline
Bank stocks also remain in the doldrums. The KBW Nasdaq Bank
Index is down 34% this year while the S&P 500 is up a
fraction.
The bank bulls see signs of strength. For example, the banks
have put aside more in loan-loss provisions than any time since
2008 and are still expected to be profitable for the year.
Eric Hagemann, an analyst at Pzena Investment Management Inc.,
said the results show the banks are increasingly able to handle
potential loan losses.
"Should the banks demonstrate such resilience, that could lead
to a structural rerating of the stocks as they begin to be treated
more like 'normal' companies," he said. "They haven't been treated
like normal companies since the great financial crisis."
Other evidence showed the underlying value of bank assets
increased in the second quarter. The average book value per share
was up 7.4% from a year earlier, said RBC Capital Markets analyst
Gerard Cassidy.
That important metric is one the bank bulls say is evidence the
stocks could rally if there is more clarity about the economy and
the virus.
The banks were trading at a median price-to-book value of about
84% in the quarter, down from 118% a year ago, Mr. Cassidy said. He
is forecasting bank stocks will return to 110% of their book
value.
"The time will come when everybody is going to jump into the
banks," Mr. Cassidy said. "Once people become convinced that the
worst of the crisis is behind us, they will realize the banks
survived."
Write to David Benoit at david.benoit@wsj.com
(END) Dow Jones Newswires
July 31, 2020 05:44 ET (09:44 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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