Despite the growing tensions in Russia, financial stocks have had a good week, with earnings results showing strong return on equity and strong EPS to shareholders, despite declining revenues in certain corners of the market. Trading continues its steady decline, with investment bankers seen less activity yielding less profits, but asset management and retail banking have provided upside for a number of investment banks and retail banks that have reported so far.
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At least, that has been the story with JP Morgan (JPM), Goldman Sachs (GS), Morgan Stanley (MS) and Citigroup (C), but other banks have not done so well. The hardest hit, Bank of America, has had some horrible numbers, despite a modest revenue beat against expectations in the second quarter and a very strong EPS beat that shows the company is doing a good job of cutting expenses.
Still, BAC saw net interest income fall 5% for the quarter over the same period a year ago, and that EPS number was adjusted for a $4b litigation expense that would have sent EPS down to 19 cents. BAC was hit hard by a $2.8 billion net loss from consumer real estate services as mortgage originations fell by a massive margin. Consumer banking rose modestly, but it remains a small part of the firm’s operations.
Much more troublingly, BAC is losing in the wealth management business, where net income fell year-over-year. While this part of the business, at $724 million, is a small share of the company’s total $11.73 billion non-interest income, it is a rapidly growing and important part of the financial services industry. If BAC is losing this, it will need to find another operation to replace it. Yet its consumer business operations, despite the strong growth, lacks real promise if BAC cannot grow its mortgage operations.
Another interesting comparison is Morgan Stanley (MS), which is down for the week but rose considerably on its earnings release with a healthy top-line and bottom-line beat and, most importantly, overall revenue growth. This means MS is not seeing its total business contract. More closely, investors see that most of the company’s operations are flat or growing—even trading and equity sales, a struggling sector, saw flat revenues year-over-year. Wealth management rose 17% year-over-year, and investment management rose 28%. MS also has a flourishing stock buyback program and its only declining business, fixed income, was partly offset by larger advisory revenue from the same industry.
Juxtaposing MS and BAC tells us two things. Firstly, a deeper dive into the fundamentals of a company’s operations is essential to understanding why one outperforms and another does not. It also tells us that indexing this sector is going to result in some inefficient asset allocation. Just buying XLF will give you much more exposure to BAC than MS—the ETF has about 3 times as much BAC stock as MS stock, due to the weighting rules of the index. Financial services, in other words, is providing active managers an easy opportunity to deliver alpha.
Of course, that is based on the assumption that the trends remain intact. It remains to be seen if macroeconomic pressures or changing demands for financial services reverses what we have seen in this quarter. Constant due diligence and a close reading of changes in the financial services industry is necessary. Those investors who take the time to do this legwork will find that they can find real undervalued bank stocks, and higher profits down the line.