Last week we looked at how the dynamics of the housing sector were likely to affect large bank earnings. This week let’s take a look at how the Sell Side analyst community is posturing itself for a “surprise” as JPMorgan and Wells Fargo get ready to release Q2 2013 results Friday before the bell.
With JPM, the first thing to say is that even with the Fed, the London Whale and various other fiascos proclaimed by the Big Media, the stock is still trading in the $50s vs. the $40s a year ago. If you took Bloomberg News and The New York Times as your benchmarks for reality, you’d think that JPM would be trading far below current levels and CEO Jamie Dimon was out. At just under 1x book value, JPM has a ~ $200 billion market cap and, you might say, is fairly valued given the lack of visibility on revenue. You can tell my pal Maria Bartiromo over at CNBC to calm down on JPM and Jamie Dimon, BTW.
The largest bank in the US has already guided the analyst community to expect an operating loss on the mortgage line as volumes fall. Paul Miller at FBR takes some comfort from the fact that the 2013 mortgage origination totals should come in close to $1.4 trillion and hopes 2014 will thus be better than expected by source such as the Mortgage Bankers Association. But the fact is that the 20-plus analysts who follow JPM -- none with "sell" ratings -- are expecting a 7% decline in revenue this quarter and this largely driven by mortgage volumes and related expenses. Weakening auto financing volumes may also be part of the narrative.
Rob Chrisman, a mortgage market commentator most readers of ZH don’t know, puts the FBR report into perspective:
“Investment bank FBR's third-quarter mortgage originations estimate is $349 billion, a 29 percent decline over the quarter. Not only are refis down, but the last and first quarters of any year are usually the low points of the purchase market, leaving lenders wondering if they've cut enough staff for volumes during the next six months. FBR estimates a 46 percent decline in refinances in the third quarter and a 2 percent rise in purchase originations.”
But, of course, we will all be surprised when JPM reports the weak performance of what has heretofore been a key revenue line, right? Despite the fact that JPM officials have been taking about the changing dynamics in mortgage markets since the Q2 2013 earnings call, there will be many people who are surprised and publicly so. That said, the same analyst group who are expecting Q3 2013 to be a wash out for JPM see revenue only down 0.8% for Q4 2013 and down just 0.5% for the full year. For 2014, the analyst group expects JPM revenue up ~ 3% but EPS up close to +10%, meaning a lot more layoffs. Naturally this is bullish for the US economy.
Likewise with WFC, the equity market valuation looks a lot better than you might expect reading the Big Media. While the nation’s largest mortgage lender is about 10% off of the 52-week highs, it is still trading 1.4x book, easily the richest valuation among the large cap universal banks. But what is fascinating is that the 23 Sell Side analysts who follow WFC are guiding to just a 1% decline in revenue in Q3 2013, but down 4.3% in Q4 and down 1.4% for the full year. Listening to the guidance coming from WFC in the past month, it seems reasonable to expect that many Sell Side analysts will be “surprised” by the WFC results. Again, Miller at FBR is a rare voice of sanity among the Sell Side contingent:
“Wells Fargo and other large banks continued to cede [mortgage market] share in 3Q13. Based on the initial GSE MBS issuance data, Wells was responsible for 19.5% of MBS sold to Fannie and Freddie in the quarter, down from 23.4% a year ago and over 30% in the beginning of 2012. Likewise, JPM, C, USB, and BAC ceded 0.2%, 0.6%, 0.7%, and 0.7%, respectively. This pullback by the largest players continues to leave room for smaller originators like [Home Street] HMST, [Nationstar Mortgage] NSM, [Pennymac] PFSI, [SunTrust] STI, and [Walter Investment] WAC to maintain volumes through market share gains in what is an otherwise declining market.”
Of note, WFC did $98 billion in refinance loans and $85 billion in purchase loans in the first half of 2013, this according to Inside Mortgage Finance. While volumes for refinance loans are expected to fall sharply in 2H 2013, purchase volumes are growing steadily, but the fastest growth rates for purchase loans are seen among the nonbanks. It is worth noting too that Miller, who has followed the large cap financials for years, is now diversifying his analyst portfolio to include the non-bank mortgage group.
Despite the minus signs on the revenue growth rates in 2H 2013, the Sell Side community expects WFC to do EPS of $3.37 in 2013 and $3.85 in 2014, a mere 14% earnings growth rate YOY. Revenue is expected to rise just one tenth of that amount, so again look for more layoffs from WFC. WFC already has a 50% efficiency ratio, the best operating leverage ratio in the peer group, so getting to the EPS number means a significantly lower headcount. All of the large banks have been managing expenses intensively over the past five years, so getting that kind of earnings lift with virtually no revenue growth means significant personnel reductions at WFC. And again, this will be bullish for the US economy, right?
One bright note in the large bank earnings picture will be mortgage servicing rights or “MSRs,” which increased in value more than 10% in Q2 2013 according to data from the FDIC. The shift in valuation came partly due to higher rates (and expectations for slower prepayments), partly because of a supply of new buyers entering the market. The adjustment in fair value of MSRs flows through income, providing the illusion of earnings growth even as the banks withdraw from the mortgage sector. The analysts who understand MSRs will likely feign surprise, while those who are clueless will remain, well, clueless. Watch for a discussion of fair value of MSRs in the earnings releases of the top five universal banks and in their subsequent 10-Qs. And don't hold your breath waiting for any "sell" ratings on these names.