Rate Cut Expectation Clouds Major Regional Bank Stocks' Outlook
Zacks Investment Research | Jul 28, 2019 09:11PM ET
The Zacks Major Regional Banks industry includes the nation’s largest banks by assets — most having operations across the globe. Financial performance of these banks largely depends on the nation’s economic health. Being involved in a number of complex financial activities, these firms must meet the stringent regulations set by the Federal Reserve.
Along with the traditional banking services, which are the source of interest income, major regional banks provide a wide array of financial services and products to retail, corporate and institutional clients — both domestic and global. The services offered include credit and debit cards, wealth management and investment banking, among others. Therefore, a major source of revenues for these banks is fees and commission earned from these services.
Here are the three major industry themes:
- Major regional banks considerably benefit from higher interest rates, as interest income constitutes a significant portion of their revenues. Higher rates also lead to margin expansion, the main indicator of a bank’s profitability. However, the central bank’s accommodative monetary policy stance on interest rate and expected slowdown in global economy are likely to affect banks’ net interest margins. Also, trade war concerns have hurt business sentiments across the industries, which will have an adverse impact on loan demand. All these are expected to hamper banks’ net interest income growth.
- These banks are investing considerably in AI and other digital platforms to improve their online and mobile banking services, and ward off competition from Fintech and other companies. In fact, banks like Bank of America (BAC) and JPMorgan (JPM) have been successful in offering customized digital services. These efforts will help banks save time and provide less error-prone services. However, these technological investments are expected to result in a rise in operating costs to some extent in the near term.
- Gradual easing of stringent regulations by the Fed has resulted in increased financial flexibility for these banks. With declining compliance costs, banks are able to utilize the freed-up capital to generate more revenues and expand operations (both organically and through acquisitions). These initiatives are expected to support profitability amid expected dismal rate scenario.
Zacks Industry Rank Indicates Bleak Prospects
The Zacks Major Regional Banks industry is a 16-stock group within the broader Zacks Zacks Industry Rank , which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
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Our proprietary Heat Map shows that the industry’s rank has remained in the bottom half of the rank list over the past six weeks.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of disappointing earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since the beginning of 2019, the industry’s earnings estimates for the current year have been revised downward by 2.8%.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and valuation picture.
Industry Underperforms Sector and S&P 500
The Zacks Major Regional Banks industry has underperformed the S&P 500 composite and its own sector over the past one year.
While the stocks in this industry have collectively lost 4.7% over this period, the Zacks S&P 500 composite rallied 6.6%, while the Zacks Finance sector has declined 1.5%.
One-Year Price Performance
Industry’s Valuation
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TBV), which is commonly used for valuing banks because of large variations in their earnings results from one quarter to the next.
The industry currently has a trailing 12-month P/TBV of 2.15X. This compares with the highest level of 2.68X, lowest level of 1.44X and median of 2.08X over the past five years. Additionally, the industry is trading at a discount when compared to the market at large, as the trailing 12-month P/TBV for the S&P 500 composite is 11.63X, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
As finance stocks typically have a lower P/TBV ratio, comparing major regional banks with the S&P 500 may not make sense to many investors. But a comparison of the group’s P/TBV ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Finance sector’s trailing 12-month P/TBV of 3.68X for the same period is way above the Zacks Major Regional Banks industry’s ratio, as the chart below shows.
Price-to-Tangible Book Ratio (TTM)
Bottom Line
The operating backdrop may turn less challenging with the easing of regulatory supervision. Also, the major regional banks will benefit from strategic initiatives and improving economy in the near term.
Nonetheless, expectation of Fed rate cuts is a major concern for these banks. Also, the support major banks receive from manageable expense levels at present might not continue, as investments in technology and efforts to find new avenues will gradually lead to rise in expenses.
Despite the near-term concerns, investors may keep an eye on a few major regional bank stocks given their strong earnings outlook.
None of the stocks in the Zacks Major Regional Bank space currently sports a Zacks Rank #1 (Strong Buy). So, we are presenting one stock with a Zacks Rank #2 (Buy) and two stock with a Zacks Rank #3 (Hold).
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BankUnited, Inc. (BKU): The stock has gained 15.9% so far this year. The Zacks Consensus Estimate for current-year earnings has been revised 1.8% upward over the past 30 days. The stock currently carries a Zacks Rank #2.
Price and Consensus: BKU
Citigroup (C): The stock of this Zacks Rank #3 bank has surged 38.6% year to date. The consensus estimate for current-year earnings has been revised 1.5% upward over the past 30 days.
Price and Consensus: C
Wells Fargo (WFC): The consensus estimate for the bank’s earnings for the current year has moved 1.3% higher over the past 30 days. The Zacks Rank #3 stock has gained 7% so far this year.
Price and Consensus: WFC
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