Tuesday, January 17, 2006

Analysts Bet on Big 3 US Banks

Earnings won't be spectacular, but analysts like shares of Citigroup, JPMorgan, Bank of America

CNNMoney.com, Shaheen Pasha, January 17, 2006: 12:59 PM EST

New York(CNNMoney.com) - Fourth-quarter earnings from banking titans Citigroup, JPMorgan Chase and Bank of America are expected to be summed up in one word: lackluster.

With an ever-flattening yield curve, an expected surge in bankruptcies and a decline in fixed-trading income from surprisingly robust third-quarter levels, analysts aren't counting on any breakaway surprises to the upside in the fourth quarter for the nation's banking leaders.

But rather than turn bearish on Citigroup, JPMorgan Chase, and Bank of America, analysts see plenty of potential for the stocks this year.

True, there are a number of negative headwinds that could put pressure on the companies.

The yield curve, which refers to the slope of rates in the Treasury bond market, is expected to have squeezed net interest margins in the fourth quarter and could continue to create a headache for bank profits in 2006. It briefly inverted in late December when the two-year note yield exceeded the 10-year yield, a rare occurrence that generally bodes badly for the economy and the financial sector in particular.

Banks and securities firms borrow money at short-term rates and lend at long-term rates. A flat yield curve, therefore, squeezes margins while an inverted one hurts a bank's profits.

"The banking industry got pinched with short-term rates in 2005," said Craig Woker, associate director of equities research at Morningstar. "But now that it appears the (Federal Reserve's) rate tightening is coming to an end, net interest margins should stay stable as banks get more visibility on how to price loans."

And Dick Bove, an analyst at Punk Ziegel & Co., said that while investors will likely be "agonizing over any net interest margins that are lost" in the fourth quarter, Wall Street should keep in mind that bank earnings are historically less affected by the slope of the yield curve and more directly hurt by a spike in loan losses.

"A careful analysis of bank earnings suggests that an increase in the loan loss provision at banks is the most compelling determinant of declines in bank profit," he said. "From 1950 to the present, every decline in bank earnings occurred in a year when the loan loss provision was rising."

Analysts added that investors may be taken aback by staggeringly high levels of credit card charge-offs in the fourth quarter as consumers raced against the clock to file for bankruptcy before the new, tougher bankruptcy laws took effect on Oct. 17.

But those concerns should also dissipate as bankruptcy filings slow down this year and banks likely see lower-than-expected charge-offs in the coming quarters, Bove said.

Jeff Harte, senior financial service analyst at Sandler O'Neill, said the capital markets outlook will remain the wild card in 2006. All three megabanks benefited from unusually strong third-quarter investment banking and fixed-income trading results. Fourth-quarter results should continue to be robust, although not as strong as the previous quarter -- a factor that may disappoint investors at first glance.

But among companies in the overall banking industry, analysts see Citigroup, JPMorgan and Bank of America as the best bets for investors.

From a valuation standpoint alone, the companies are ripe for the picking, said Morningstar's Woker.

Citigroup's stock ended the year up a mere 0.7 percent, while shares of JPMorgan managed to finish the year 1.7 percent higher and Bank of America fell 1.8 percent in 2005. Trading roughly at 10.5-times 2006 projected earnings, analysts said the companies were trading at a steep discount to their regional competitors, which trade at about 12.5-times earnings.

Of the three, Punk & Ziegel's Bove was particularly bullish on Citigroup's prospects. He said the company is poised for strong growth in its investment banking unit as M&A activity picks up steam.

And after a spate of regulatory woes in recent years, he said Citigroup's restructuring efforts -- such as the sale of non-core businesses, the implementation of a new rigid ethics model and the resignations of top executives that had served under the former CEO Sanford Weill -- should bear fruit and spur growth this year.

Bove has a 12-month price target of $62 on Citigroup.

Morningstar's Woker said JPMorgan's stock will climb as more details emerge regarding how successfully it integrated Bank One following the 2004 acquisition. He said that while earnings "numbers were ugly since buying Bank One," the company was focused on the integration and setting the stage for strong earnings growth this year.

"I would anticipate that this company will have the best bottom line growth by far in 2006 and 2007," he said, which should spark investors' interest. He said the company, which traded recently at about $40 a share, is fairly valued at $57.

And as for Bank of America, investors will be paying close attention to any benefits it derives from the $35 billion acquisition of MBNA, analysts said. Bove said the company will benefit from its trading operations and, while it has made a mark in serving the consumer market, he expects the company will continue to aggressively expand into the corporate finance arena.

Bove has a 12-month price target of $62 for the stock, which traded recently around $45 a share.