Earnings season is well underway for US banks, with Bank of America’s share price up following a Q2 earnings beat, while Wells Fargo’s stock ticked lower on concerns over profitability following their update last week.
The results come among worsening macroeconomic conditions and the continued drag of the US-China trade war. Around the corner, the Fed has suggested that it could cut interest rates at the end of July.
Still, the financial sector is expected to come out on top in what has been a fairly dismal earnings season. According to S&P Global Market Intelligence, going into Q2, expectations had been for the sector to grow 4.3% in earnings per share compared with the same quarter last year.
Looking at the factors behind both banks’ quarterly numbers reveals some issues that traders will need to weigh up before picking up shares in either stock.
Bank of America share price up on earnings beat
Bank of America's [BAC] share price might be up 17.79% this year, but since its 29 April $30.80 high it has shed over 5% in value.
Yet that didn't stop the bank crushing analyst Q2 earnings forecasts with a record-beating $7.3 billion worth of profit, up 8% jump from the same quarter last year. This translated to a healthy earnings per share of 74 cents, topping expectations by 3 cents. Revenue came in at $23.2 billion, up 2.1% and in line with estimates.
BoA's strength this quarter lay in its retail divisions. Consumer banking, the bank's biggest division, saw profits rise 13% to $3.29 billion. This was fuelled by the bank’s deposit and loans business, which were up 3% and 6% respectively.
However, BoA revised its annual net interest rate lower from 3% to 2%. This is an important measure of any bank’s profitability, and there is a danger it could sink lower.
Chief Financial Officer Paul Donofrio attributed the decline to lower long-term interest rates. It seems that more people paying off their mortgages has led to an increase in the redemption of mortgage-backed securities. This has seen the bank having to "write off some premiums".
Donofrio also highlighted how a possible interest rate cut at the Fed could impact profits: “If rates follow the forward curve, and the Fed funds rate were indeed to be cut twice this year starting this month, we think it would likely shave another 1 % off [Net Interest Income] growth for 2019.”
Wells Fargo share price slips on net interest income concerns
Wells Fargo [WFC] Q2 numbers saw earnings per share come in at $1.30, beating the $1.15 forecast on Refinitiv. Revenue of $21.58 billion also beat the expected $20.93.
Despite the beat, Wells Fargo’s share price finished 1% down last week as investors focused on the bank's lower-than-expected net interest income. Also weighing on investors’ minds were comments that expenses were likely to remain at the higher end of forecasts until 2020.
As a fundamental source of profit, a significant disappointment was net interest income’s miss of the anticipated $12.1 billion. Margins from net interest dropped 9 basis points compared to the first quarter of the year, to come in at 2.82%. CEO C. Allen Parker pinned the blamed on higher deposit costs and low interest rates.
Still, payouts to investors were up 52% compared to the same period last year. The bank returned $6.1 billion to shareholders by way of dividends and share repurchases. Parker also mooted a plan to bump up the quarterly dividend to 51 cents in Q3.
So far this year Wells Fargo's share price is down 2%, pacing well behind the 18% gains made by the S&P 500. Worryingly, this downward trend has dragged on since 16 March, with the share price falling 11% from a high of $52.70.
Who to buy?
The consensus among analysts is that Bank of America is either a “Strong Buy” or a “Buy”. An average price target of $33.5 would represent a 13% upside on the current share price. The bank carries a forward P/E of 9.58 and a low price-to-book ratio of 1.11 for the most recent quarter, so the current share price could well represent decent value.
|Bank of America||Wells Fargo|
|PE ratio (TTM)||10.47||9.47|
|Operating Margin (TTM)||41.16%||36.53%|
Bank of America & Wells Fargo share price vitals, Yahoo finance, 22 July 2019
Wells Fargo also carries a low forward P/E, coming in at 9.71 and a price-to-book ratio of 1.15. Yet, the majority of analysts tracking the stock rate it “Hold”. The stock’s average price target of $49.04, would represent around 6% upside. While a decent bump, this doesn’t match the expected growth of BoA. In any case, traders might want to hold fire to see if the Fed does cut interest rates later this week as any trim could affect both banks’ profitability.