Banks are among the first to kick off the upcoming U.S. earnings season. Several of the largest U.S. banks are reporting on Jan. 15, including Citigroup, Wells Fargo and JPMorgan Chase & Co.
Along with most of the financial sector, banks were among the hardest hit during the Covid-19-induced bear market. However, many have recently regained some favor – with price performance outpacing even some of the most popular tech sector stocks in recent weeks, as can be seen in Exhibit 1 below. By contrast, the tech-heavy Nasdaq 100 has been essentially flat over this four-week period.
Exhibit 1 shows the largest U.S. banks, with market caps that exceed $10 billion. Over the last four weeks, their prices have appreciated between 9.9% and 25.1%. While some are still down over the last 52 weeks, most notably Wells Fargo and Citigroup, this 52-week Price PCT Change column is looking considerably better than it did just a short while ago.
Exhibit 1: Price Percentage Change over Four- and 52-week Time Periods
Source: Refinitiv Eikon
It’s hard to know for sure what’s changed investor sentiment toward banks. It could be we’re witnessing a rotation from growth to value stocks. It could be a “reflation trade” with Democrats taking both the White House and eliminating the Senate Republican majority. Or, it could be a positive change in fundamentals and/or economic conditions.
Using traditional relative valuation ratios, banks have long been among the cheapest stocks. In fact, their unpopularity contributed to the massive underperformance of value factors, indices and funds, relative to their growth counterparts, over the last few years.
A fundamental change may be contributing to the recent interest in bank stocks. Exhibit 2 shows a sharp steepening of the yield curve. While short-term maturities remain near zero, yields at 5, 10, 20 and 30 years are considerable higher, relative to short-term maturities, than they were one year and two years ago.
If the shape of the U.S. yield curve maintains this shape, it could provide a significant boost to banks’ lending profits as they lend at longer durations while still paying next to nothing in interest to depositors.
Exhibit 2: U.S. Treasury Bond Yield Curve
So far though, that assumption has not shown up in most analyst estimates for net interest margin (NIM). Net interest margin is a common measure of a bank’s profit margin. It is a measure of the difference between what they receive in interest payments relative to what they pay out.
Exhibit 3 shows these companies sorted by their last actual full-year NIM results. This would be, for most, in pre-pandemic calendar year 2019.
Next to that is displayed estimates for fiscal year 1 – the 2020 results soon to be announced and, in the next column, analyst estimates for the quarter just ended. To improve the accuracy of these estimates, we use the StarMine SmartEstimate™, a Refinitiv proprietary measure that places more weight on the historically more accurate analysts and the more recent estimates.
Most analysts still expect 2020 NIMs to be below that of the prior year and the last quarter to come in below full-year results.
Exhibit 3: Net Interest Margin: Actuals and Estimates
Source: Refinitiv Eikon, Refinitiv StarMine
In Exhibit 4, you can see that for the year just ended but not yet reported, the SmartEstimate for EPS is in most cases considerably lower when compared to last year’s actual results in column 1.
However, analyst estimates, in most cases, are being revised upward. That is reflected in the StarMine Analyst Revisions Model (ARM) scores in column three.
The ARM model is a comprehensive measure of the change in analyst sentiment. It incorporates revisions activity across the income statement, looking not only at EPS revisions but also revisions in EBITDA and revenue. Components include current quarter, full-year, and next-year revisions. It also incorporates changes in analyst recommendations.
Shown below, numbers represent a 1-100 country-relative rank, where 100 is best. So, for example, by this measure of changes in estimates and recommendations, Wells Fargo now ranks in the top 2 percent of all companies in the U.S. That’s something we haven’t seen for a while.
Exhibit 4: StarMine Analyst Revisions Model: A positive change in sell-side sentiment
Source: Refinitiv Eikon, Refinitiv StarMine
The Tier-1 Capital Ratios shown in Exhibit 5 are a measure of capital adequacy. Tier-1 capital measures the least risky assets on a bank’s balance sheet compared to all its risk-weighted assets. It is a measure of a bank’s financial strength. In the U.S., regulatory requirements impose a minimum Tier-1 ratio of 4.5%. Under Basel III requirements, the minimum ratio is 6%. A bank is generally considered well-capitalized if it has a Tier-1 ratio of 8% or higher.
In both last year’s actual financial results (column 1 of Exhibit 5) and 2020’s SmartEstimates (column 2), all of these large banks easily exceed the minimum requirements and also what is considered a “well-capitalized” level. This may put hope back on the table for a resumption of share buybacks and/or dividend increases.
Exhibit 5: Tier-1 Capital Ratios: Actuals and Estimates
Source: Refinitiv Eikon, Refinitiv StarMine
Conclusion
As the largest U.S. banks begin reporting their financial results later this week, after the worst economic conditions they have faced since the 2008 financial crisis, they are certain to receive a lot of attention.
Earnings numbers may be ugly. However, there seems to be encouraging signs in the data. Stock prices have lately been appreciating strongly, reflecting greater optimism among investors. Sell-side analysts have also become more optimistic, as reflected in their estimate and recommendation revisions. The yield curve is currently accommodative and, should it continue to remain steep at the long end, may boost net interest margins. Finally, highly capitalized banks may even get the green light to resume share buybacks or dividend hikes.
