Can you believe third-quarter earnings season is right around the corner? Starting next week, corporate earnings will be back in focus -- and many of the large-cap banks will kick things off next Tuesday.
We'll be out with our views on all the AAP names reporting next week, but let's take some time and go over the banks, because they're at the heart of U.S. economic activity. Banks are said to "set the tone" for earnings season. Their results are crucial because they provide a unique perspective on both the domestic and global economic backdrop.
Large financial institutions are uniquely positioned to discuss consumer and business sentiment across all industries simply because they're the money centers for all economic activity. After all, they do everything from extending lines of credit and aiding in merger-and-acquisition talks.
As a result, banks have direct insight into what's going on with spending and borrowing -- which speaks to the outlook that their customers have on the economy. Remember, people don't borrow more money or increase their spending if they fear an economic slowdown is coming.
How should readers assess upcoming bank earnings? Well, in addition to watching the "headline" numbers (revenue and earnings per share), keep an eye on:
Return on Equity (ROE) and Return on Tangible Equity (RoTE)
These two profitability measures evaluate how effective a bank is at generating profits from its assets. Generally speaking, consistently stronger values lead to higher multiples.
Net Interest Margins (NIM)
This is the spread between what banks pay on deposits and what they charge for loans. As a result, NIM is directly tied to profitability.
NIMs likely faced pressure during the third quarter due to the U.S. Treasury yield curve's flatness/inversion. We also expect banks to talk about lower net interest income for the quarter because we got more Federal Reserve rate cuts than markets had expected.
Tangible Book Value Per Share (TBVPS)
This is essentially what a bank's value would be if the firm had to shut down and liquidate all positions.
We like to look at a bank's price to tangible book value per share (P/TBVPS) even before we look at price to earnings (P/E). That's because the former metric is highly representative of the bank's true value.
Although we're long-term investors, updated TBVPS typically sets a new floor and ceiling for a bank's trading range, which we use when determining how to handle our positions. And generally speaking, we're of the belief that financial stocks tend to trade in the general direction of book value. So, we'll be watching to see if a bank increases its TBVPS rather than decreasing it.
As noted above, responsible consumers and businesses don't increase borrowing when they expect an economic slowdown. As a result, we consider a bank's loan growth a key "tell" on business and consumer sentiment.
That being said, any increases in bad loans with credit risk would represent a negative to us.
The Efficiency Ratio
Also known as a bank's "overhead ratio," this measures operating expenses as a percentage of revenues. It allows investors to see how lean the bank is running -- i.e., what it costs a firm to produce revenues before factoring items such as tax.
Why We Buy Bank Stocks for the Portfolio
Although many banks have seen sluggish top-line numbers recently, we'd remind you that many financial stocks have become good yield plays in this market.
That's been made possible by many firms successfully passing the Federal Reserve's annual Comprehensive Capital Analysis and Review (CCAR) tests. Passing these tests allows a bank to distribute excess capital to shareholders.
As we detailed in our alert here, many banks have recently passed their CCARs and boosted their dividends and share buybacks. For example, Citigroup (C) increased its quarterly dividend to $0.51 from a previous $0.41 and announced a $17.5 billion stock buyback.
Similarly, JPMorgan Chase (JPM) hiked its quarterly dividend to $0.90 from an earlier $0.80 and announced a new $29.4 billion buyback. And Goldman Sachs (GS) -- which was viewed as a big winner of CCAR -- increased its quarterly dividend to $1.25 from a previous $0.85 and announced a new $7 billion buyback.
With all of this in mind, let's take a look at what analysts are expecting when the bank stocks that we hold in the portfolio release their results next Tuesday.
FactSet's consensus estimates for Citi's third quarter currently call for the bank to report $18.536 billion in total revenue, $1.95 in earnings per share, $69.01 of TBVPS, NIM of 2.66% and a 56.2% efficiency ratio.
We want to see good expense control and a solid return on tangible common equity that puts Citi on track to achieve its longer-term objectives.
You can see our commentary from Citi's second-quarter results here.
We hope to see JPMorgan report good loan activity and evidence of a healthy consumer. We'll also be paying close attention during the conference call to CEO Jamie Dimon's perspective on the global economy.
FactSet's estimates for JPM project total revenue at $28.465 billion, earnings per share at $2.45, $59.32 in TBVPS, 2.41% NIM and an efficiency ratio of 57.2%.
Our commentary about JPM's second-quarter earnings can be found here.
We'd like to see Goldman offer more updates on the consumer business, and also want to learn more about the firm's new Marcus online bank and its Apple Card partnership. We think Goldman has a fantastic story to tell, but the question is: "Will the market listen?"
At the time this was written, FactSet consensus estimates called for Goldman to report $8.307 of total revenue, earnings per share of $4.81, TBVPS of $206.30, NIM of 0.548% and 67.9% efficiency ratio.
Click here to read our analysis of Goldman's second-quarter results.