- The third quarter results outperfomred the expectations, but fourth quarter results might be slightly disappointing for the diversified banking industry but in the long term, external factors are in their favor.
- During 2023 the interest rate environment will likely grow their net interest income further and the return of the M&A and investment banking activity will support their non-interest income segment.
- Due to the steady price decline during 2022, these stocks are trading at attractive valuations with record-high dividend yields.
Diversified banks industry stocks have been declining for more than 12 months on average now. JPMorgan Chase & Co. (NYSE:JPM) has been declining for 13 months, Citigroup Inc. (NYSE:NYSE:C) has been on the decline for 15 months and Bank of America Corporation (NYSE:NYSE:BAC) stock has been declining for 8 months after a short peak in February 2022. The decline pushed dividend yields to record highs with attractive company valuations. So the question is: is it time to buy diversified banking stocks?
Generally speaking, growing interest rates are good for banks. Their profit margin widens and the net interest income grows. Citigroup’s management expects that a 100 basis points parallel shift in rates, and cross-currencies, would increase the bank's NII by $2.5 billion. In a rising rate environment, net interest income revenues flourish while non-interest income such as investment activity and M&A declines. As investors saw in the banking sector’s second quarterly results the NII growth was much higher than the investment banking and M&A activity revenue decline and this trend is likely to continue throughout the rest of 2022. The risk factor is the rapid growth of interest rates because then the interest expense will grow accordingly and in addition, higher-than-expected loan defaults could occur.
This is why banks are preparing for a long recession and has been increasing their provisions for loan losses in the last 2 quarters and it is expected that Q3 will be no different. It means that after a great 2021, when almost all banks reduced their cash reserves for problematic loans that can go bust, 2022 changed significantly. They are building up large "cash cushions" for the upcoming economic slowdown. This will lower their profitability and profit margin in the upcoming months so investors have to consider this fact when buying banking stocks.
However, this short-term profit decline in the banking sector just makes the companies more attractive because it is only a short setback. Inflation is expected to be under control by the first half of 2023, the job market is stable with record low unemployment rates (3.5% in September), and the fed will likely maintain an average of 2.5-3% interest rate level during 2023. That means great profits for diversified banks. By the beginning of 2023 cash reserves will be built up, so no further money will be taken away from their balance sheets, inflation decline will mean consumer confidence will grow and loan volume will likely increase. The net interest income part of their revenue will likely be growing and at the same time, the non-interest income revenue segment will come back after a disappointing 2022.
Attractive Valuation
Bank stock prices have been slowly declining during the past quarter, and banks with repurchase plans in place had ample opportunity to buy back shares at discounted prices. The banks could not only lower their shares outstanding at great prices but also could slightly increase their EPS while maintaining shareholder value.
Investors have not seen these attractive valuations for diversified banks for a long time (except for the pandemic crash for a couple of weeks). C trades at record lows of only 0.435x price-to-book ratio, well below its 5-year average of 0.78x. Both BAC and JPM are trading at low price-to-book ratios compared to their 5-year averages. BAC trades at 0.997x its book value and its 5-year average is 1.19x. JPM trades at 1.18x to its book value and its 5-year average is 1.58x. Across the diversified bank industry, investors can see attractive valuations and banks trading 20-40% below their book value.
Record dividend yields
Price decline and growing dividends caused banking stocks to be traded on record dividend yields. This could be a great buying opportunity for long-term income investors as investors have not seen such high dividend yields for diversified banks in the last 5 years. This is an opportunity that is only temporary and rare. Stock prices might go down another 5-10% in the upcoming months due to lower reported profits but in the long term, external factors are in their favor. JPM, BAC, and C’s dividends are well covered, and their payout ratio is between 25-33% so investors do not have to fear potential dividend cuts.
Investor takeaway
In the third and fourth quarters, investors might see slightly declining banking profits due to banks building up their cash reserves and non-interest income revenues. This might result in a slight decline in stock prices in the upcoming weeks. However, this is only temporary because all of the external factors are in their favor in the long term and that is why it is a great buying opportunity for income-seeking investors who want to get exposure to the diversified banking industry.