There’s not much to cheer about when it comes to the financial services sector these days.
One after another, the megabanks are forking over billion-dollar fines to settle everything from accusations of criminal wrongdoing (such as the admission by French bank BNP Paribas that it routinely violated U.S. laws against doing business with nations such as Iran and Cuba) and helping Americans avoid taxes (Credit Suisse’s $2.6 billion penalty, finalized in May, was triple what UBS agreed to pay in 2009).
The latest in the line of prodigious penalties was Citigroup’s $7 billion agreement with the Justice Department, announced Monday, to settle charges it misled investors about the mortgage-backed securities it was selling.
These fines are bad enough, but the big banks are also facing big headwinds to profits, Citi’s better-than-expected adjusted results notwithstanding. There’s no market volatility; trading volumes are low and so are interest rates. All of that is bad news for anyone who makes a living from trading — and that includes the investment banking divisions at firms like Citigroup, Goldman Sachs and Morgan Stanley. The outlook is pretty gloomy, as banks unveil their quarterly results this week.
Indeed, of all 10 sectors in the S&P 500, financials offer the weakest outlook, according to data from Thomson Reuters I/B/E/S. Companies in the S&P 500 index as a whole are expected to post earnings growth of 6.1 percent, with technology firms forecast to grow profits by 12.3 percent. Financial services companies, which led the pack a year or so ago, are now a drag on the S&P 500 as a whole, stuck firmly in last place.
Overall, analysts are calling for earnings to decline 3.5 percent in the second quarter. So while financial stocks may be cheap — trading at 1.35 times book value, compared to 2.73 times book value for the S&P 500 — that is, in most cases, offset by a distinct lack of earnings growth.
In other words, the financials are cheap for a reason.
But not all financial services stocks are big banks, or S&P 500 companies. Indeed, Keefe, Bruyette & Woods, Inc., a boutique investment bank specializing in financial companies, issued a list last week of some companies that it believes are particularly inexpensive — and particularly appealing for the rest of 2014.
The names on the KBW list don’t include any of the big banks — or any of the companies your mind tends to fly to when you hear the words “finance” and “Wall Street.”
Popular, Inc. (NASDAQ:BPOP)
Puerto Rico and TARP? Not an appealing combination… But Popular, Puerto Rico’s largest bank and the biggest one left in the TARP program, made its final payment under the plan only weeks ago. Puerto Rico’s economic situation isn’t exactly encouraging, but the bank was able to make the payment without having to raise fresh equity, which is encouraging to Keefe, Bruyette & Woods analysts. They argue that investors are underestimating Popular’s earnings power and applying too great a discount to its shares. There’s plenty of upside potential in a post-TARP life, they predict.
Intercontinental Exchange (NYSE:ICE)
Fresh from the IPO of Euronext (at a higher price than KBW analysts expected), the company is on track to complete cost savings and see higher earnings even if revenues don’t grow. If trading volumes do pick up, that’s a bonus: ICE has a dominant brand and offers investors a “call option” on businesses ranging from swap execution to credit clearing.
Signature Bank (NASDAQ:SBNY)
Since the beginning of 2013, Signature Bank has snapped up 15 private banking teams from rivals, and continued to expand its specialty finance operations. Loan growth (which remains concentrated in the New York City/Long Island area) has remained at about 30 percent, with the KBW analysts predicting growth of at least 29 percent and 25 percent in 2014 and 2015, respectively — while noting that the bank has a history of trouncing its forecasts. It’s a pricey stock, relatively speaking, and there is concentration risk, but the fundamentals still suggest that it’s worth that price, the analysts argue.
Alliance Data Systems Corp. (NYSE:ADS)
Back office stuff is boring? Not for this company, which operates right where the payments business meets commerce and marketing. It oversees airline reward programs and helps retailers provide co-branded credit cards by offering receivables financing as well as processing and marketing. In the short term, in contrast to the angst surrounding the big banks, analysts have been revising upward their forecasts for Alliance’s next earnings report.
KKR & Co. (NYSE:KKR)
Demand for alternative investments remains robust, KBW analysts say, and KKR (formerly known as Kohlberg Kravis Roberts & Co.) is pushing further into the hedge fund universe. Moreover, there is lots of potential for future cash distribution on private equity transaction profits. KKR plans to distribute the cash flow that it produces to investors; that, KBW suggests, will be great news for those investors and ultimately will be reflected in the company’s share price. The downside? Well, if the capital to distribute doesn’t show up in the first place…
Synovus Financial (NYSE:SNV)
The Georgia-based lender, hurt by the housing crisis and its effects in the Southeast, has been cutting costs and increasing lending activity. KBW is anticipating an increase in the bank’s dividend and, although it remains cautious about the housing market in Georgia and the surrounding region, argues that the selloff in Synovus shares this year isn’t justified by anything in the company’s fundamentals.
XL Group (NYSE:XL)
Investing in an insurance company can often feel like rolling the dice: Will a natural or man-made disaster come along and wipe out all your profits? The analysts at KBW hone in on the facts that XL has hefty loss reserves and improving results, as well as other factors that suggest the odds favor share repurchases — and thus a higher stock price down the road. (Buybacks have historically been a big part of generating value for the company’s investors.) Insurance rates are still climbing, the analysts note, and there’s room for earnings to rise and for the company’s valuation to close the gap with its peers.
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