Is it Worth Holding onto Big Banks?

09/26/2013 11:00 am EST


Jim Jubak

Founder and Editor,

Given the way the big banks are looking, is there any reason to buy or hold onto any of them right now? The answer MoneyShow's Jim Jubak, also of Jubak's Picks, has, may surprise you.

We know that the big US banks are going to deliver a lousy third quarter, when earnings season starts with Alcoa (AA) on October 8.

So, is there any reason to own any of the big US banks as the sector gets ready to stink up the joint?

Maybe. Selectively. And I'd say Citigroup (C) would be my top pick among big US banks right now. (Citigroup is a member of my Jubak's Picks portfolio.)

It's hardly a secret that third quarter earnings are going to be bad, since the big banks have been cutting jobs in their mortgage units right and left as refinancing volumes slump. Citigroup has let 1,000 people go in its mortgage unit, and Wells Fargo (WFC) has fired 4,000. JPMorgan Chase (JPM) has told Wall Street to expect a 20% to 30% quarter-to-quarter drop in mortgage banking revenue in the quarter.

And that's just the beginning of the sector's woes. Revenue from trading is likely to fall heavily in the quarter on a slowdown in fixed-income revenue. JPMorgan and Barclays have said that third quarter trading revenue for 2013 is likely to be below that for the third quarter of 2012. Citigroup revenue from fixed-income, currency, and commodities trading is likely to fall by 25%, including the Sanford C. Bernstein & Co. project.

Let's finish off our litany of woes with the piles of cash that big US banks are paying-or are likely to pay-to regulators or investors. For example, JPMorgan Chase will pay $920 million to settle charges that it violated federal securities laws in the London Whale trading scheme. The company faces a likely $3 billion to $7 billion settlement of $11 billion in claims over the packaging of mortgage bonds that cratered in the global financial crisis. Citigroup has agreed to pay Freddie Mac $395 million to resolve repurchase claims on mortgages that the bank sold to the company.

It's the very visibility of all this bad news that makes the sector more intriguing than it might seem. Some big part of the bad news is already out there. Shares of Citigroup, for example, are down 5.7% from September 18 through the close on September 25. That's a big drop for a week. JPMorgan Chase has fallen 8.6% from August 1 through the close on September 25. Wells Fargo is off 6.2% from August 2 through the September 25 close.

There's definitely the possibility of a bounce in shares of big US banks after these kinds of drops. You can see that potential in the 2.4% bounce in JPMorgan shares yesterday, September 25, on news that the company was in talks to settle that $11 billion in potential mortgage claims.

But that potential bounce runs right into a longer-term story that is likely to keep pressure on the financial sector in general. If interest rates have plunged in the days since the Federal Reserve's no taper decision on September 18-and yields on 10-year US Treasuries have tumbled to 2.63% as of September 25, from an early September high slightly above 3%-there's a very good likelihood that they will begin to climb again as we approach the December meeting of the Federal Reserve's Open Market Committee on December 18. And if the financial markets start to think, after the beginning of any taper, that the Fed might start to raise short-term interest rates before 2015, then banks and financials, in general, face even stronger headwinds.

So, I'd like any big bank stock that I own, therefore, to have something going for it besides a potential bounce, as we head into third quarter earnings season.

Last quarter, Citigroup demonstrated that it had that something else in the form of gradually improving bad loans at Citi Holdings, the company's huge bad bank. In the quarter, Citigroup released $525 million in reserves against the Citi Holdings mortgage portfolio. Citigroup continued to wind down its assets in Citi Holdings-they were down by $60 billion in the June quarter from the second quarter of 2012-but the bad bank still has plenty of work to do with $80 billion in its North American mortgage portfolio alone. Given the continued strength of the US housing market, I think it's reasonable to expect the release of another few hundred million in reserves against that portfolio this quarter.

Citigroup investors have to try to balance the negatives in the short-term story against the positives in the long-term credit story. After the decline in the stock over the last week, I think it's worth holding Citigroup shares through the October 15 earnings results.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund , I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Citigroup as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund's portfolio here.

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