The Dow Jones is up over 11% for the year so far and the euphoria on Wall Street has certainly hit Main Street. The one sector that has not participated in this rally is major U.S., large-cap banks. The stock performance of the major six banks has been as low as down 10% to flat -- in other words lousy. The six major banks are Citigroup (NYSE: C), Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC), Wachovia (NYSE: WB) and Washington Mutual (NYSE: WM) and JP Morgan Chase (NYSE: JPM). So is time to start nibbling away at these stocks?
The central issue is the state of the subprime mortgage market. All of these banks are major mortgage players in the United States, from coast to coast. As the earnings season was approaching with first quarter results, many thought the answers would be evident and that the issue would be a memory. All six reported very good, solid first quarter results, and reserve requirements were raised for the year to absorb defaulted mortgages. Washington Mutual explained that they were aggressively working with the subprime customers to refinance their loans before the problems got worse. Wells Fargo, Bank of America, and Wachovia followed suit.
The earnings were strong for the first quarter and guidance for the calender year 2007 stayed the same, no lowering of forward expectations. Dividends are absolutely solid in terms of earnings/dividend coverage, and the yields are mouth-watering. The yields on the big six range from 3.2% to 5.2%.
The stocks have been flat to down as the mortgage issue is not yet totally resolved. The housing market is still a troubling aspect of the economy, with no real relief in sight until at least 2008. That factor has kept these stocks depressed. But remember, you want to buy when no one else is.
Five of the six are having an up year for earnings, and the troubled Citigroup is turning itself around through various restructuring programs. As mentioned, the dividends are solid and will probably be raised before the year is out. The PE ratios are cheap, between 10 to 12 times 2007 earnings. The PE ratios are at a discount to the 16.5 times PE on the S&P 500. What is the catalyst?
The main catalyst will be when investors are comfortable that reserves will no longer have to be raised to cover potential bad debts. The other catalyst will be when investor perception is that mortgage application rates are back to normalized levels. With many subprime mortgage issuers now out of the business, the big six will actually reap the growth of the mortgage underwriting business when it turns. The forward growth rates for 2008 and 2009 could potentially go higher.
The dividend yields will provide the downside protection on these six stocks. The risk/reward profiles are looking more favorable, and after this week's earnings report, much of the mortgage issue will be better understood. I doubt if earnings will be radically altered to the downside.
The six big banks are interesting and appealing at these prices. The patient investor will be well-rewarded over the next two years by starting to buy and build positions at these levels.
Georges Yared is the Chief Investment Strategist of Yared Investment Research.
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Reader Comments (Page 1 of 1)
7-14-2007 @ 12:21PM
Richard .D Marshall said...
Please persue the underbrush re:JPM-
7-14-2007 @ 2:55PM
Paul E Taylor Jr said...
Of course they are great buys!!!!! Today they make over 33%of their inclome from FEES!!!!! That compares to 3 to 4% years ago. Gives new meaning to
BANKS - LEGALIZED LOAN SHARKS!!!!!!!!!!!!
7-14-2007 @ 2:56PM
Paul E Taylor Jr said...
Of course they are great buys!!!!! Today they make over 33%of their inclome from FEES!!!!! That compares to 3 to 4% years ago. Gives new meaning to
BANKS - LEGALIZED LOAN SHARKS!!!!!!!!!!!!