Big bank earnings are behind us. After hearing from the nation’s biggest institutions over the past couple weeks, we can breath a sigh of relief: They were better than feared. Many investors were understandably worried about the banking sector heading into this first-quarter earnings season following the collapse of Silicon Valley Bank (SVB) and two other U.S. lenders in March. But the biggest worry — that a flight of deposits from regional institutions to “too big to fail” banks would destroy investor sentiment — never happened. As a result, we’ve been able to focus solely on company fundamentals and what they may foretell about the economy and markets. Banks provide a inside look at the state of the consumer, specifically savings and credit levels, which in turn show how well positioned the consumer is to ride out an economic slowdown. Here are our winners for the two main segments of the sector, and how they compare to our two bank holdings in the Charitable Trust. We tried to take a holistic approach, using factors such as reported results versus expectations, historical performance, and absolute metrics within the peer groups. Investment banks Goldman Sachs (GS) and Club holding Morgan Stanley (MS) are the two pure-play investment banks we care about. They mostly provide services to large corporations and institutional investors (Citigroup and JPMorgan also have divisions that do this, but we put them in money center group since they also accept deposits and make loans to regular consumers and small businesses.) Of the two, Morgan Stanley posted the better first-quarter results, beating on both the top and bottom lines; Goldman missed on sales but beat the Street’s estimate for profits. Both investment banks, however, oversaw declines for both headline numbers. This just isn’t a good economic environment for investment banks, given the lack of initial public offerings and M & A activity; these banks collect huge fees shepherding deals for their clients. Goldman beat Morgan Stanley on one key metric: return on tangible common equity (ROTCE), which measures the bank’s ability to generate a return on its book (assets on balance sheet). Morgan Stanley had a better absolute number, but Goldman beat expectations. During earnings season, it’s all about beating expectations; as longer-term investors we value Morgan Stanley’s stronger performance (expectations aside) as it serves to support a more premium valuation. The exact opposite can be said for the efficiency ratio: Goldman put up a better number but missed expectations, while Morgan Stanley’s result edged out the consensus expectation (see chart 1). Goldman had a much larger annual jump in its efficiency ratio, which we never like to see; lower is better on this front. Also working to Morgan Stanley’s advantage is the better-than-expected result we got on the non-interest revenue line. Morgan Stanley also had $110 billion of net new assets come into the firm during the quarter, nearly double the $57 billion at Goldman This indicates Morgan Stanley management’s ongoing effort to diversify the business is working — and makes it the investment bank best-positioned to ride out an economic downturn. Money center banks JPMorgan Chase was the clear-cut winner of the four main commercial banks this earnings season. It put up the best numbers versus expectations and and in many cases — sales, earnings, annual growth, the efficiency ratio, ROTCE — on an absolute basis (see chart 2). Our runner-up is Wells Fargo (WFC). The Club name reported the second-best annual sales and earnings growth of the group, the greatest efficiency ratio improvement, and by far the strongest net interest margin on an absolute basis. Of special note: Wells Fargo was the only big bank to see non-interest expense actually decline versus the year-ago period. Third place was tight, but the combination of better earnings growth and a significantly better ROTCE made Bank of America (BAC) the better performer. Citigroup (C) had a better net interest margin, but its earnings didn’t look quite as good after excluding divestiture-related impacts and the bank’s ROTCE was below its peers. Sizing up bank valuations Morgan Stanley is currently trading at a premium at 13.7 times forward earnings, compared to 10.3 for GS. That valuation is warranted given the recent results, its premium ROTCE profile and management’s execution of things it can control. Recent acquisitions E-Trade and Eaton Vance are also gathering reporting solid growth in gathering assets. Goldman, on the other hand, still seems to be searching for direction in regard to its consumer business Marcus — especially now that partner Apple (AAPL) has launched its own, higher-yielding savings account with the bank. This could cause some cannibalization though management doesn’t believe it to be a major risk . Morgan Stanley also boasts a better dividend yield, paying us to wait until investment banking activity returns. For the commercial banks, JPMorgan unsurprisingly has the highest valuation at 9.9 times forward earnings and 2.2 times tangible book value, a valuation metric for banks. It also has the lowest dividend yield. JPM is the premium name of the sector. Wells Fargo and Bank of America have similar valuations — both at 8.8 times forward earnings. BAC has a higher dividend yield, but Wells Fargo has a lower P/TBV valuation. We’re sticking with Wells Fargo because it has more room for improvement on expenses. The eventual removal of the just over $1.9 trillion asset cap imposed by the Federal Reserve in 2018 in response to several scandals at the bank could be a very positive catalyst. This would free the bank to issue additional loans and ultimately return more cash to shareholders. Both things will improve the bank’s ROTCE and efficiency ratio. Citigroup’s big beat on earnings has to be taken with a grain of salt because sentiment on the name is about as bad as it gets. The current valuation of 8.1 times forward earnings and its 0.6 times tangible book value support that view. On the bright side, you are getting a pretty hefty dividend yield. We would still rather pay up a little for Wells Fargo thanks to the self-help nature of our investment thesis (cost reductions, actions to please regulators), especially at a time of so much macroeconomic uncertainty. Citigroup is currently trading below tangible book value — usually an absolute steal. However, if you bought Citigroup in the past decade based on the P/TBV being below 1, you’ve learned the hard way about how frustrating it can be to own a “value trap.” With a few pops here and there, this bank has largely traded below tangible book value going back to the Great Financial Crisis of 2007-2009. The reason for this valuation is largely tied to the bank’s poor ability to generate a return on tangible common equity. The book of business is worth more if management can generate a greater return on it. JPM has by far the best ROTCE and highest P/TBV multiple, then comes Bank of America, followed by Wells Fargo and finally Citigroup. The same is true for the investment banks. Morgan Stanley sports a high ROTCE, supporting its premium valuation multiple. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
Morgan Stanley Chairman and Chief Executive James Gorman speaks during the Institute of International Finance Annual Meeting in Washington, October 10, 2014.
Joshua Roberts | Reuters
Big bank earnings are behind us. After hearing from the nation’s biggest institutions over the past couple weeks, we can breath a sigh of relief: They were better than feared.
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