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Back in January, I first started talking about 2015 being the year of big bank breakups. The idea is that all the major banks have two major businesses: consumer and investment banking.
I suggested that if these were separated, it could unlock value for shareholders. In the near-term, the big bank breakup talk subsided after many of the banks passed the Federal Reserve’s annual stress tests with flying colors.
Well, things got a little more interesting last week, with all the big bank stocks posting first-quarter earnings. Goldman Sachs (NYSE: GS) was one of the biggest standouts, beating on earnings and sales expectations. But that comes thanks to its strong investment banking presence. Goldman is one of the leaders in the merger and acquisition advisory business.
And M&A activity has been picking up thanks to the cheap debt that comes from low interest rates. Then there’s Goldman’s trading desk, where market-making revenues jumped 50% from the same quarter last year.
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Now, in terms of the big banks, JPMorgan Chase (NYSE: JPM) once again impressed, with the bank posting quarterly earnings growth of 12% on a year-over-year basis. One of the standouts for JPMorgan, like Goldman, was the strong growth in advising revenues for M&A transactions. Its trading department also posted solid growth.
Wells Fargo (NYSE: WFC), meanwhile, saw its profits fall on a year-over-year basis. This is the first time the company saw a decline in quarterly profits since 2010. It also saw its net interest margin decline, despite being able to grow its deposit base. But Wells Fargo remains strong, having bought some of General Electric’s (NYSE: GE) financial assets earlier this month.
The key takeaway from this round of big bank earnings was that the notion of a breakup is still very real. Although JPMorgan is the biggest bank in the U.S. by assets, making the case to break up this outperformer is still very hard.
Ultimately, it seems logical (and easiest) to target one of the two laggards, Bank of America (NYSE: BAC) or Citigroup (NYSE: C). Since the start of 2009, all the other major banks are up at least 100%. Meanwhile, Citi shares are down 21%, while BofA is up just 17%.
Even still, I’m taking the idea of breaking up Citi off the table. In part, this is thanks to the bank’s stellar results from the Fed’s stress test. Back then, however, Bank of America was already under scrutiny. As part of its stress test, the Fed noted that there were weaknesses in BofA’s internal controls. It has until September to resubmit its capital plans.
And when it comes to the big bank turnaround stories, Citi was the standout in terms of earnings reports last week, while BofA was a big disappointment. Citi is seeing marked success in controlling expenses and growing trading revenues.
The increase in trading across the market is being driven by low interest rates and the potential for a more volatile year in the markets. Those factors should be key positives for the banks with large trading divisions, such as Citi, JPMorgan and Goldman Sachs. Bank of America, however, is still wading through legacy mortgage-related issues, which further pressured earnings last week.
From a valuation perspective, Bank of America is still the cheapest big bank. Its price-to-book ratio stands at 0.7, while Wells Fargo is on the high end at 1.7. Yet, is BofA cheap for a reason? Its dividend yield isn’t all that bad at 1.3%, but its return on equity is just 1.7%.
I still believe there’s a better bet in the banking business.
JPMorgan has a near double-digit return on equity and still trades just over book value, with a P/B ratio of 1.1. With a dividend yield of 2.8%, it just might be the best bank stock to buy right now.
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