Keefe, Bruyette & Woods (KBW), a full-service, boutique investment bank
and broker-dealer that specializes in the financial services sector, and
a wholly owned subsidiary of Stifel Financial Corp. (NYSE:SF), has
released its 2015 U.S. banking sector outlook. KBW analysts expect a
variety of factors to impact bank stock performance in the coming year,
including an expected rise in interest rates, continued regulatory and
legal risks, and improvements in market and lending conditions.
Universal Banks: Sector in Transition
For 2015, Universal Banks will benefit from improved market and lending
conditions including increased market volatility, which should boost
trading activity and higher short-term rates, which should result in
improved margins. However, these banks will face increased risks outside
the United States along with regulatory and legal headwinds. KBW expects
the ultimate end point for bank regulatory ratios to finally be
determined in the coming year, but it expects those ratios will be
meaningfully higher than what is currently required. As a result, upward
performance will be limited as returns compress. KBW does not view
price-to-earnings valuations as attractive and regulatory and litigation
risks also remain a potential overhang on stock performance.
“We are recommending that investors maintain a market weight position in
Universal Bank stocks,” noted Frederick Cannon, KBW Global Director of
Research. “Universal Banks should benefit from higher short-term rates,
but we believe the benefits are already reflected in earnings and
valuations. It is our view that upward estimate revisions will be the
main driver of stock performance in 2015 for Universals. However, most
banks lack tangible catalysts to drive earnings per share above our
current estimates.”
Within Universal Bank stocks, KBW rates The Goldman Sachs Group (GS) and
State Street Corporation (STT) at “Outperform” and all the remaining
stocks at “Market Perform”. KBW continues to like the fundamental
outlook for STT and believes the stock is at an attractive valuation
relative to peers based on return expectations and growth outlook. The
firm also believes that Goldman Sachs will continue to outperform since
its valuation is still reasonable and the company will benefit from
improving capital markets activity along with market volatility and
economic growth.
KBW is “Market Perform” on the remaining Universal Bank stocks (BAC, BK,
C, JPM, MS, and WFC) as earnings-based valuations are not cheap and
catalysts for earnings growth above current estimates appear remote
given the current macro conditions and regulatory environment. KBW would
look to own the group when valuations improve relative to the broader
market or if differentiated outlooks arise relative to other banks
groups. KBW expects Universal Banks will continue dealing with
litigation and regulatory risks throughout 2015 and this will limit the
upside in share appreciation.
Large Regional Banks: It’s All About the Fed
The fight between lackluster growth today and the promise of better
growth when the Federal Reserve raises rates is likely to be on display
in 2015. With the sector trading at a lower relative price-to-earnings
multiple than last year and expectations that the Fed will finally raise
interest rates, KBW can envision the stocks doing reasonably well in the
early stages of the year, as hope springs eternal. However, KBW believes
the perceived leverage that is already embedded in earnings estimates
must come to fruition or the stocks are at risk later in the year. As a
result, KBW maintains a market weight position on the group for 2015.
Heading into 2015, KBW thinks the large-cap banks are still at risk for
downward earnings estimate revisions, as its 2015 and 2016 estimates
remain 2-3% below consensus. The analysts’ view is that the Fed will
keep interest rates lower for longer and will move in a very slow manner
once it tightens, and that the yield curve flattens as low global rates
anchor long-term U.S. rates. This will result in a less optimistic
earnings outlook than consensus.
Even if KBW’s fundamental view proves accurate, it may not matter for a
period of time. The analysts believe investors are willing to look
through the lack of revenue growth and tepid earnings growth in the
sector today for the promise of better growth when interest rates rise.
In addition, the value investor is discovering that it is hard to find
areas of interest given the surge in valuations of many other non-bank
sectors. Analysts see a 21% discount to the broader market and a
sector’s fundamentals that are positively levered to an increase in
interest rates while other industries could be negatively impacted.
“The true test will come after the Fed raises interest rates,” said
Christopher Mutascio, Head of Large-Cap Bank Research at KBW. “Our
concern is that a fair amount of net interest margin expansion is
already embedded in estimates and investor expectations,” he added. “If
the net interest margins don’t expand to the degree that is expected a
quarter or two after the Fed starts to raise interest rates, then the
bank stocks could be vulnerable, especially as the loan loss provision
expense inflects and provides an offset to modest margin expansion.”
KBW likes names that can grow net interest income regardless of what the
Fed does or does not do (HBAN) and the isolated names in which the
analysts believe the consensus estimates are too low (STI). KBW is more
cautious on names that have massively outperformed in 2014 on lackluster
earnings quality (WFC) and names with expensive valuations despite
slowing growth engines (USB).
SMID-Cap Banks: Estimate Revisions Key to the Stocks
Earnings revisions, not price-to-earnings expansion, drove this year’s
performance in the small-and mid-cap bank (SMID) stocks. In order to get
the stocks right in 2015, KBW believes it will once again come down to
the direction of estimates. In-line valuations with historicals and the
risk of lower rates for a longer time period keep KBW neutral on the
group—although it remains selectively constructive on differentiated
business models and select asset sensitivity.
On the positive side, KBW remains generally encouraged by the loan
growth recently produced by the SMID-cap banks and believes the group
remains poised to continue to take market share from its larger brethren
and grow at a multiple of GDP. In addition, credit quality still remains
very strong and while reserve releases aren’t providing the earnings
kicker that they did a couple of years back, KBW believes losses are
likely to remain well below historical levels for the foreseeable
future. Finally, building M&A momentum—primarily (but not exclusively)
on the smaller side—is an additional consideration for the group as it
relates to driving incremental earnings growth, as well as improved
sentiment altogether.
“The SMID bank group isn’t without its challenges, most notably the
impact on bank profitability from the persistently low interest rate
environment both domestically and abroad,” noted Jefferson Harralson,
Head of Small-Cap and Mid-Cap Bank Research at KBW. “The resulting
impact on bank net interest margins (NIM)—the most meaningful input to
forward estimates—remains significant. In addition, expense headwinds
from increased financial regulation remain a consideration for
underlying bank profitability entering 2015, though regulatory headline
risk appears to be showing some signs of abating.”
Investors can contact their KBW representatives to obtain copies of the
KBW bank outlooks. Members of the press interested in obtaining copies
of the full reports or who wish to schedule an interview with a KBW
analyst should email kbwpr@intermarket.com.
About KBW
KBW LLC, a Stifel company, operates in the U.S. and Europe through its
broker dealer subsidiaries, Keefe, Bruyette & Woods, Inc. and Stifel
Nicolaus Europe Limited (“SNEL”), also trading as Keefe, Bruyette &
Woods Europe (“KBW Europe”). Over the years, KBW has established itself
as a leading independent authority in the banking, insurance, brokerage,
asset management, mortgage banking and specialty finance sectors.
Founded in 1962, the firm maintains industry-leading positions in the
areas of research, corporate finance, mergers and acquisitions as well
as sales and trading in equities securities of financial services
companies.
Copyright Business Wire 2014