Why Elections Are Good For Bank Stocks

election.jpgKeefe, Bruyette & Woods’ [research] team is out with the note: “The Election Edge: Elections Have Historically Benefited Financials,” which reviews the impact of recent U.S. presidential elections on the equity market and financial stocks.

While performance trends from the ’08 election are undeniably impacted by the financial crisis, we still found several overarching trends. For a longer performance history, we used the NASDAQ Bank Index to measure trends in bank stocks around elections back to 1984, the first year the exchanges were open on Election Day. We are unable to replicate such long-dated analyses for the other financial industry groups due to lack of industry index data prior to 1995 and in some instances, the lack of an investable public equity universe historically (e.g., REITs).

  • Financial stocks rallied and outperformed the market going into three of the last four presidential Election Days. Financials outperformed the market and posted gains in the YTD period up to Election Day in ’04, ’00 and ’96. This outperformance did not hold true in ’08, when financials were impacted by the financial crisis. However, similar trends are playing out in ’12 through 9/21 as financials increased 21.8 percent while the S&P 500 index (SPX) rose 16.1 percent.
  • Among financials, banks consistently outperformed the market going into the last four elections. Both large and small to mid-cap banks (SMID) outperformed the SPX in the ’08, ’04, ’00 and ’96 elections. As with the financials, similar trends are playing out in ’12, with the large-cap banks rising 27.5 percent and SMID-cap banks increasing 17.6 percent, both outperforming the SPX’s 16.1 percent gain.
  • Longer-term analysis back to the 1984 election shows similar outperformance trends for banks. Banks as represented by the NASDAQ Bank Index outperformed the SPX during the year-to-date period up to Election Day in all seven presidential elections going back to 1984.
  • Similar performance trends hold true for the four-week period leading up to Election Day. Financials outperformed in the ’08, ’00 and ’96 elections over the four weeks prior to Election Day while banks (large- and SMID-cap) outperformed during this period in all four last elections. Banks, as represented by the NASDAQ Bank Index, also outperformed in this four-week period prior to Election Day in every election since ’92.
  • Election Day is not historically a market-moving event. With the exception of 2008, the SPX rose between 0 to 1 percent on Election Day. Financials exhibited similar performance, ranging from a decline of 0.4 percent to a gain of 1.6 percent in the ’96-’04 elections.
  • Financial stocks underperformed post-Election Day through year-end in three of the last four presidential elections. Financials lost their steam once the election was over, underperforming the market in the post-election period in ’08, ’04 and ’96.
  • Despite the underperformance of financials, life insurers and diversified financials outperformed post-Election Day through year-end in three of the last four elections. Life insurers and diversified financials underperformed the market and posted losses after only the ’08 election, when performance was significantly impacted by the financial crisis. Long-term post-Election Day results are mixed for the banks, with the NASDAQ Bank Index underperforming the SPX in three of the last seven elections (’08, ’04, ’88).
  • Election Day is rapidly nearing and will occur on Tuesday, November 6.

Analyst Report: Community Banks Saw Improving Metrics In The First Quarter

piggy-bank-health.jpgInvestment firm McAdams Wright Ragen has recently released its first quarter 2012 Community Bank Report which includes over 1,100 publicly traded banks and thrifts and provides data broken down by asset size as well as by region. The report is a unique look at many of the banks that aren’t traded on the NYSE Euronext or NASDAQ OMX, which so get little attention in the world of equity research. When looking at a bank’s asset size in comparison to the level of non-performing loans still held on the books, the statistics show a wide variation between the largest and smallest institutions. The average Texas ratio for the largest institutions (28 percent) is much lower than that for the smallest institutions, those with under $250 million in assets (43 percent). A similar story plays out in values. Banks above $25 billion in assets traded at an average of 129 percent of tangible book value. Banks below $250 million in assets traded at an average of 69 percent of tangible book.  Smaller banks have less access to capital markets, which could impact values, but many of them have more troubled loans on the books as well, which impacts the Texas ratio. A ratio above 100 percent is an indication of a potential bank failure.

When examining regional trends, every region has seen improvement in recent quarters in almost every important metric (price/tangible book, price to earnings ratio, Texas ratio, tangible equity/tangible assets). The three areas of the country where the banks have seen the greatest improvement in price and credit (the Southeast, Southwest and the Midwest) were hardest hit by the depression in the housing market and credit crunch. While these regions’ cumulative statistics have seen the greatest improvement since the third quarter of 2012, they still lag behind those of the Northeast and West.

The full report can be accessed here.

Third quarter earnings review: bank stocks rally as clouds thin

cloudy-skies.jpgRenewed optimism from the Eurozone, in-line or better than expected domestic economic data, and solid third quarter performances all have contributed to a widespread rally in stocks. The BKX index (comprising 24 large-cap banks) was up 2.4 percent and the S&P 500 was up 1.1 percent for the week ending Oct. 21.

We believe that the banks can continue to display strong price performances as we witness thinning investment clouds related to the Eurozone, sustainability of the economic recovery, regulatory environment, and the mortgage mess. The industry should also benefit from a substantial underweighting of bank stocks in institutional portfolios, relatively low expectations, valuations well below historical levels, and loan loss reserve and capital levels near all-time highs. Once global fears lessen, we expect bank stocks to perform relatively well in a slow growth environment marked by gradually improving fundamentals and double-digit growth in earnings.

Quarter-to-date, all but one of the nation’s 40-largest banks (comprising our industry average) has posted gains, with 35 banks up more than 5.0 percent and our industry average up 11.4 percent. Thus far in fourth quarter, the BKX index has advanced 10.1 percent and the S&P 500 has risen 9.4 percent. In the third quarter, the BKX index was down 26.9 percent and 14.3 percent for the S&P 500. Second quarter 2011 earnings, encouraging as they may have been, were undermined by distressing macroeconomic, political, and regulatory headlines. The last time banks traded at these price levels was in July 2009, when we were also confronted with similar concerns. However, fundamentals have substantially improved over the past two years and the industry appears well positioned to withstand another economic downturn with relatively little pain.

Bank balance sheets have been fortified, capital and reserve levels are near all-time highs, the system is flooded with liquidity, the irrational players have been removed, and we have few accounting or regulatory rules to change.  Granted, the implementation of Dodd-Frank will be a longer-term drag on profitability, but offsets and constructive changes are likely to follow a Republican victory in November 2012.

We are likely about two years away from normal profitability levels, and many banks trade at very attractive valuation levels with estimated double-digit growth rates for net income through 2013. Based on Street estimates (which have already been substantially adjusted for the very low interest rate environment), we expect our industry average to post earnings per share advances of more than 40 percent in 2011 and more than 25 percent in 2012. Yet, among the nation’s 40-largest banks, 27 trade below book value with the weighted average price-to-book ratio at 92 percent and the weighted average 2012 estimated price to earnings ratio at 9.6x (compared to about 150 percent and 12.5x, respectively, for our 15-year industry average).

Thus far in the third quarter earnings season, results have been highlighted by improved credit quality, accelerated growth in commercial loans, and increased mortgage banking income. Also, expense savings programs and balance sheet adjustments have become more prevalent as banks look to mitigate anticipated margin contraction from the current interest rate environment. Market-related revenue has been very weak (as expected) due to seasonality and market disruptions this quarter, but generally in-line or better-than-expected earnings per share has been driven by accelerating loan growth, strong mortgage banking gains, lower provision levels, and tighter control of operating expenses. However, the flattening of the yield curve and anemic balance sheet growth should continue to put downward pressure on the net interest margin (NIM).

Why bank stocks underperform

Fred Cannon and Melissa Roberts of Keefe, Bruyette and Woods spend a lot of time dissecting the markets to understand financial stocks. Here, they give their views on how capital raises have affected the long-term performance of bank stocks, and which banks will do best when interest rates rise.

melissa-roberts.jpgMelissa Roberts is the senior vice president of quantitative research at Keefe, Bruyette & Woods. She leads a team of financial services research analysts. She holds a degree in Economics from Colgate University.

fred-cannon.jpgFred Cannon is the director of research and chief equity strategist for Keefe, Bruyette and Woods.  He has worked as Director of Investor Relations both for Golden State Bancorp and Bank of America. Fred holds a Master’s Degree from Cornell University and BS Degree from the University of California at Davis, both in agricultural economics.

What might change the underperformance of banks going forward?

Fred: It’s very important to recognize that the banks have underperformed the broad market for the last couple of years not necessarily because they haven’t been able to generate earnings, but because they’ve diluted the share count so much because of the capital raising.  It means stock prices just can’t recover to their pre-crisis levels. Citibank’s share count went from 5 billion shares to 30 billion shares.   

How much equity are financial companies raising?

Melissa:  For the entire market, they usually contribute roughly 40 percent to 50 percent in a non-crisis period.  When we got to the height of the crisis in 2008, they contributed as much as 87 percent of the total additional capital that was being raised, and that was primarily due to the TARP issuances.  In the first quarter of 2011, we found out financials were around 50 percent, but the bulk of that additional capital was really for real estate companies, not banks. 

You do a lot of other research on financials.  What surprising or interesting factors have you found influence bank stocks?

Melissa:  If you look at a stock that has a large amount of short interest, it could sometimes be thought of as a future positive for the stock, because if you’re not saying that that stock’s going to go to zero, at some point, those shorts have to cover. The large-cap banks had a maximum short interest level on March 31, 2009, where 5.9 percent of tradable shares were owned by investors shorting the stock.  Then they came down to a minimum on August 13th of 2010 of 2.6 percent. As the short interest levels were coming down in large-cap banks, those shorts were forced to cover the stock and that probably was a contributing factor to some of the outperformance of the large-cap banks.  What’s also interesting here is that if you look at when the large-cap banks hit a minimum, it’s almost simultaneous with when the regional banks hit a maximum. It seems like investors are rotating their themes.

Fred:  But I have to say some heavily shorted stocks did go to zero, so that theory doesn’t always work.

What will be the impact of rising interest rates on bank stocks?

Fred:  What you’re really looking for is banks that have both very sticky deposits that won’t leave, even when rates go up, and variable rate loans that will adjust upward with higher interest rates. I think on our list some of the ones who’ll benefit the most include Silicon Valley Bank, The PrivateBank out of Chicago, and Comerica. We believe that the Fed is on hold for short-term interest rates until the second half of 2012.  We think that until bank lending begins to grow, the Fed is going to be on hold. Ironically, the region of the country that has the slowest loan growth historically is now having the best, which is the Northeast. M&T Bank and then First Niagara, I think those are two good examples of banks who avoided much of the sins of the financial crisis, as their region did, and now are able to grow. 

What are bank investors looking for now?

Fred:  The bank stocks haven’t performed great in the first quarter, but 74 percent of the 79 bank stocks we track met or beat earnings in the first quarter. It’s not just about beating earnings; it’s also about showing that you can grow your revenue.

Forward looking statement:  We believe that the Fed is on hold for short-term interest rates until the second half of 2012.  We think that until bank lending begins to grow, the Fed is going to be on hold.