Comments from The Clearing House conference, which met for the first time in person since 2019, hinted that loan demand would take a long time to normalize, suggests Jason Clark, value investor and editor at The Prudent Speculator.
Multiple crosscurrents and apparent fears of recession have driven the KBW banking index down over 16% year-to-date, broadening the appeal of several of our banks.
Among the hardest hit this year is Capital One Financial (COF), which trades for just 6 times the 2023 EPS target, having fallen over 30% over the past year. We acknowledge the higher risk that naturally comes with COF predominantly being a card issuer.
However, we think punishment of shares over higher marketing spending has been overdone, especially as the bank increasingly goes after what management has deemed “heavy spender” customers, which it also says have exhibited lower credit loss with higher payment rates on average.
Bank of America (BAC) has a leading base of consumer deposits which makes it a favored holding. Indeed, the APY on BAC’s savings accounts was recently less than 10 basis points. Of course, high rates are available for preferred customers although those often have multiple lines of business and carry significantly higher balances with the bank on average.
Fee income from mortgages and investment banking have taken a large hit in 2022, but we expect trading revenue to benefit from market volatility in Q3. Shares trade for 10.9 times next 12 months EPS estimates and offer a 2.5% dividend yield.
We also continue to like PNC Financial (PNC), which dusted off a familiar playbook with its purchase of BBVA USA branches, a deal remarkably similar to the bank’s successful buy of RBC’s southeastern branch network in 2011.
We like the latest acquisition, which was integrated over four months, as it expands PNC’s access to 29 of the top 30 Metropolitan Statistical Areas across the country. Management said in June that momentum for new product sales (particularly within commercial) is on a strong trajectory.
With nearly 60% of income from rate spreads and strong credit performance, we find higher interest rates, very low-cost funding and the bank’s strong capital base highly favorable. A 28% drawdown from the high in January leaves shares attractively priced at 11 times next 12 months EPS estimates and brings the dividend yield to 3.7%.
And on the smaller end, Citizens Financial Group (CFG) trades for just 7.5 times the 2023 EPS estimate. Citizens had been on its own buying spree, scooping up $9 billion of deposits from HSBC, acquiring Investors Bancorp and adding a small capital markets firm, JMP Group (not the best timing) last year.
While capital markets activity has hit a snag, we think the moves complement and round out its existing territory in the Northeast, while adding stability through additional fee generation over time. Shares offer a generous dividend yield of over 4%.
The rapid ascent of interest rates will likely take some time for borrowers to stomach given the last two years of nearly free access to capital and as prices have soared.
Even as loan demand is questionable in the near-term, current (and rising) rates should support higher net interest margins as deposit costs are often slow to catch up. And yes, credit costs will likely normalize higher, but we think the industry remains well capitalized, with each of 33 banks passing the Federal Reserve’s latest Stress Test in June.
