Tags: banks | stocks | citigroup | wells fargo

Investors Need to Be Selective About Banking Stocks

Investors Need to Be Selective About Banking Stocks
(Dollar Photo Club)

By    |   Tuesday, 10 October 2017 03:32 PM

Later this week 3Q 2017 earnings season will kick off for the banking sector with reports from Citigroup, JPMorgan Chase, Bank of America, Wells Fargo and PNC among others. This initial set of companies will set the tone for what we’ll hear from others, like Bank of NY Mellon, U.S Bancorp, BancorpsSouth and dozens of other banks in the following week.

Since September 8 we’ve seen a pronounced move higher in the shares of those banks set to lay the groundwork this week, with an average price return of 12% vs. just 3.8% for the S&P 500. Two of the likely catalysts for the shares moving higher over the last several weeks is the expectation for higher interest rates over the coming quarters given the Fed’s most recent monetary policy statement and the potential for tax reform, which would likely help jump start the anemic U.S economy.

Yet when we look at the escalation in personal debt levels due to the continued climb in credit card and student related debt vs. tepid wage growth that has sapped disposable income, one has to be concerned over the increasingly strapped household budget of a growing number of Americans. This has led Morgan Stanley’s Richard Wiles to recommend investors underweight banks given concerns over higher interest rates leading to household cash crunches and the potential for lending standards to tighten. We’ve certainly talked about that as part of our Cash-Strapped Consumer investing theme here at Tematica.

What this means is investors looking to put capital to work in banking stocks will need to be selective. That selection process can include many facets from loan growth, quality of the loan portfolio, and cost containment. It goes without saying that earnings generation as well as both the current stock price relative to its valuation metrics also play an important part in the selection process. We’ve also seen a growing number of investors look at Environmental, Social and Governance (ESG) data to evaluate their investment prospects. In the case of the banks, Governance is arguably the most critical one following the 2008 financial crisis that gave rise to the Dodd–Frank Wall Street Reform and Consumer Protection Act.

The purpose of these various screens is to ferret out the best positioned company while minimizing potential risk. Given the number of domestic bank stocks, this means looking for reasons to say “no” to many of them. When adding this Governance layer of scrutiny to the mix, one that investors are inclined to cast off is Bank of New York Mellon Corp given the number of issues it has faced over the last several quarters. These include

  • Paying $3 million to resolve an investigation by the Massachusetts Securities Division over the failure of its accounting system that caused a slew of problems pricing mutual funds in 2015.
  • Britain's financial regulator, the Financial Conduct Authority (FCA), fined Bank of New York Mellon roughly $186 million for failing to comply with rules intended to keep client assets safe in case the bank became insolvent between November 2007 and August 2013. Breaches also included failing to take necessary steps to prevent these safe custody assets being mixed up with other accounts, and on occasion using them to settle other clients’ transactions without prior consent.
  • In 2016, it was announced Bank of New York Mellon would pay a $30 million penalty after the Securities and Exchange Commission (SEC) found over a decade of violations in its foreign exchange business. Per the SEC, the bank misled and overcharged some clients in its “Standing Instructions” program.
  • This summer Bank of New York Mellon was fined $3 million for “unsafe and unsound practices” that led to the bank misstating its capital for more than three years. According to the Federal Reserve Board, the bank “incorrectly assigned the assets a zero-risk weighting, which was improper under the rules in place at the time.” This “improper regulatory accounting treatment” led to Bank of new York Mellon to overstate its capital for nearly 14 quarters.

If the assumption that most investors would like to sleep at night, this means minimizes the number of unknowns and risks in their portfolio. Given the rash of issues with Bank of New York Mellon, investors would be wise to put their energy into assessing other banks for their investing portfolio.

Christopher (Chris) Versace is the Chief Investment Officer at Tematica Research, editor of the newsletter Tematica Investing, co-host of the Cocktail Investing Podcast and is a featured columnist to The Street.com as well as a contributor to Business Insider and Forbes.com

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Later this week 3Q 2017 earnings season will kick off for the banking sector with reports from Citigroup, JPMorgan Chase, Bank of America, Wells Fargo and PNC among others. This initial set of companies will set the tone for what we'll hear from others, like Bank of NY...
banks, stocks, citigroup, wells fargo
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2017-32-10
Tuesday, 10 October 2017 03:32 PM
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