R. Christopher Whalen
Jul 7, 20225 min
July 7, 2022 | Premium Service | What are the best banks for investors seeking to weather the storm of consumer price inflation and equity deflation that currently grips global markets? For long-time readers of The Institutional Risk Analyst, this is a simple question to answer. In times of market volatility and suddenly ended delusions of easy money, the prudent path is to fly to quality. Below we take a look at how some of the best performing US banks did through the end of the first half of 2022 and what to expect next from some of the exemplars among the group.
By far the best performer in 1H 2022 has been Raymond James Financial (RJF), which is down roughly 10% so far this year. At 2x book value the regional bank and advisory business has managed to hold its ground better than its larger peers. With just $72 billion in total assets, RJF ranks 42nd in the US among bank holding companies (BHCs).
The St Petersburg, FL, BHC, however, has $1.1 trillion in private client group assets, 56% of which are in fee-based accounts. RJF makes 4x as much profit and revenue from its advisory activities as it does from the bank. Notice that RJF has significantly out-performed Morgan Stanley (MS) in the first half of 2022, largely due to the larger organization's market exposures.
Next on the list after RJF is Discover Financial (DFS), the credit card issuer that is also the 37th largest BHC at $107 billion in total assets. DFS is down just 15% YTD and most of that in the past month. DFS is currently trading at 2.2x book while the larger monoline card issuer, CapitalOne Financial (COF) is trading at 0.8x book. What gives? Both are consumer lenders with gross loan spreads near or above double digits.
The major difference between DFS and COF is profitability. DFS is twice as profitable as COF measured by net income vs average assets. DFS has a higher default rate and a higher gross loan yield than COF, and a higher cost of funds than its peers. Yet the management of DFS delivers significantly better financial performance quarter after quarter. One big reason: Asset turns. DFS manages its balance sheet far better, with over 100% of average assets deployed in earning assets. COF, by comparison, had just 91% or ten points below DFS deployed in earning assets.
Readers of The Institutional Risk Analyst will recall that DFS for many years has been one of the best performing US BHCs in terms of asset and equity returns. It’s constant companion in this regards is American Express (AXP), another high performing card issuer that reached 6.5x book value during the QE stock price inflation. Indeed, DFS and AXP frequently trade first place in terms of market value and overall financial performance.
At almost $200 billion in assets, AXP is the 20th largest BHC in the US and often the top performer among large banks in financial terms. AXP reported net income of 4.5% vs average assets in Q1 2022 compared to 4.6% for DFS and just 1% for Peer Group 1. Now you know why few of the top-four US mega banks are highlighted in this report. The difference between AXP and DFS seems to be the greater consistency of the former in terms of earnings, which shows up in a 20% higher market multiple.
Next on the list are two names our readers know when, Wells Fargo (WFC) and Toronto Dominion (TD). Both names attract attention because they are large cap stocks and because they are relatively cheap compared to the group. We previously wrote about WFC (“Bank Earnings Setup: JPM, USB, WFC, BAC & Citi”) and TD (“Profile: Toronto Dominion Bank”).
WFC is a down-on-its-luck story that some equity managers find attractive, much in the same way that some investors like underperformers such as Bank of America (BAC). These larger names have poor equity and asset returns, and but offer the comfort of liquidity.
TD is a large, mediocre asset manager and lender that has the same characteristics as BAC and WFC, but with little exposure to the global capital markets. The $520 billion asset US arm of TD is one of the worst performers financially in Peer Group 1. In Q1 2022, TD Group US Holdings reported net income to average assets of 0.71%, significantly below the Peer Group 1 average.
Finally, we come to U.S. Bancorp (USB), which at this writing was down 16% at the end of June 2022 but has outperformed JPM and the other large money centers. USB has above peer financial performance, a very large domestic payments business and little exposure to the capital markets. But the fact is that JPM has fallen twice as much as USB has in the first half of 2022.
At 1.5x book, USB is not particularly cheap, but we own the preferred and may start nibbling on some of these better performers in coming weeks. Given the current rate of inflation, many stocks are cheap by definition. That said, all of the financials that we track could move significantly lower in coming months as the FOMC desperately tries to regain some measure of credibility when it comes to inflation. Banks are, after all, 100% correlated to interest rates.
Disclosures: EFC, CVX, CMBS, NVDA, WMB, BACPRA, USBPRM, WFCPRZ, WFCPRQ, CPRN, WPLCF, NOVC
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