The U.S. government’s efforts to flood the markets with cash in the face of the coronavirus pandemic has proved to be a double-edged sword for banks by propping up borrowers but leaving institutions flooded with excess cash. This idle cash is likely to remain on their balance sheets for the coming year. Due to this, it is likely that it will take a few years for many banks’ margins to return to pre-pandemic levels. If they choose, banks could quickly move this excess cash to investments that could help boost earnings per share. However, this is partly predicated on a rising stock market, of which there is no guarantee. At the same time, the pandemic pushed many banking customers to conduct business through digital channels, including those offered by well-funded financial technology firms or fintechs. Amid a challenging earnings environment and changing competitive landscape, some banks are working to modernize their offerings, while others are pursuing mergers in the face of daunting challenges.
In 2022, rising interest rates and a more cautious stance by regulators toward household borrowing are likely to slow credit growth, although it is expected to remain higher than pre-pandemic rates across the globe and in nearly every region. For the nation’s biggest banks, however, even a small increase in the Federal Reserve’s benchmark rate could lead to billions of dollars in revenue, since the banks can charge more on loans but aren’t likely to pay depositors more. Post-crisis regulations mean banks hold more short-term loans, which can quickly reprice to higher interest rates. For instance, banks no longer hold many 30-year mortgages. Instead, they have lots of auto and commercial loans, which tend to last only a few years.
Bank merger and acquisition (M&A) activity should continue to heat up as institutions seek scale to combat the challenging earnings environment. Easing credit concerns have brought buyers back into the fray, while potential sellers see transactions as a way to mitigate revenue headwinds from excess liquidity and low interest rates by cutting costs, including through consolidating branches.
Overall, many banks were able to get through the early pandemic due to sizeable support measures from the federal government and the Federal Reserve. However, it is unlikely to continue as many of these measures are being phased out or have already been removed. The government aid and forbearance provided by U.S. banks that kept many borrowers afloat left banks with large amounts of cash on hand that are likely to stick around for the foreseeable future. Additionally, banks will be focusing a lot on what the Fed does this year. Banks will be watching interest rate changes closely as well as the Fed’s take on the economy as a whole.
Grading Big Bank Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three big bank stocks—Bank of America, Fifth Third and Wells Fargo—based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Big Bank Stocks
What the A+ Stock Grades Reveal
Bank of America (BAC) is a bank holding company and a financial holding company. The company is a financial institution, serving individual consumers, small- and middle-market businesses, institutional investors, corporations and governments with a range of banking, investing, asset management and other financial and risk management products and services. BofA, through its banking and various non-bank subsidiaries, throughout the U.S. and in international markets, provides a range of banking and non-bank financial services and products through four business segments: consumer banking, which comprises deposits and consumer lending; global wealth & investment management, which consists of the two primary businesses Merrill Lynch Global Wealth Management and Bank of America Private Bank; and global banking, which provides a range of lending-related products and services; global markets, which offers sales and trading services and research services. Bank of America is one of the largest financial institutions in the U.S., with more than $2.5 trillion in assets.
Bank of America has an A+ Growth Grade of C. The growth grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow. The company reported third-quarter 2021 revenues of $12.3 billion, up nearly 7% from $11.5 billion in the year-ago quarter. It reported quarterly diluted earnings per share of $0.85, growing 67% from $0.51 per share year over year. The company reported non-GAAP operating income of $11.7 billion, up 28% compared to the prior-year quarter.
Bank of America has a Momentum Grade of A, based on its Momentum Score of 82. This means that it ranks in the top tier of all stocks in terms of its weighted relative strength over the last four quarters. The weighted fourth-quarter relative strength rank is the relative price change for each of the past four quarters.
The company has an average Value Grade of C and a Quality Grade of D, based on respective scores of 46 and 29. Bank of America has a current dividend yield of 1.9% and is held in the Stock Superstars Report (SSR) portfolio.
Fifth Third Bancorp (FITB) is a bank holding company. The company conducts its principal lending, deposit gathering, transaction processing and service advisory activities through its banking and non-banking subsidiaries from banking centers located throughout the Midwestern and Southeastern regions of the U.S. It offers a range of loan and lease products with various payment terms and rate structures. It provides commercial and industrial loans, commercial mortgage loans, residential mortgage loans, commercial leases, home equity, credit cards and other consumer loans and leases. It also offers various types of deposits, such as demand deposits, interest checking deposits, savings deposits, money market deposits and other time deposits. The company operates through four business segments: commercial banking, branch banking, consumer lending and wealth and asset management. The company has over $200 billion in assets and is headquartered in Cincinnati, Ohio.
Fifth Third has a Value Grade of B, based on its Value Score of 35, which is considered in the range of good value. The company’s Value Score ranking is based on several traditional valuation metrics. The company has a score of 41 for the enterprise-value-to-EBITDA ratio, 10 for shareholder yield and 35 for the price-earnings ratio (remember, the lower the score the better for value). Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the price-to-sales, price-to-free-cash-flow and price-to-book ratios.
The company has a strong Quality Grade of B, a very strong Momentum Grade of A and has a current dividend yield of 2.7%.
Wells Fargo (WFC) is a bank holding company. The company is a diversified financial services company. The company provides banking, investment and mortgage products and services, through banking locations and offices, the internet and other distribution channels to individuals, businesses and institutions in states, the District of Columbia and in countries outside the U.S. The company provides consumer financial products and services including checking and savings accounts; credit and debit cards; auto, mortgage and home equity; and small business lending. It provides other financial planning, private banking, investment management and fiduciary services. Wells Fargo also provides financial solutions to businesses through products and services including traditional commercial loans and lines of credit, letters of credit, asset-based lending, trade financing, treasury management and investment banking services. Wells Fargo is one of the largest banks in the U.S., with approximately $1.9 trillion in balance sheet assets.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the quality grade shows that stocks with higher quality grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
Wells Fargo has a Quality Grade of B with a score of 62. The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a quality score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
The company ranks strongly in terms of its buyback yield and return on invested capital, ranking in the 88th and 83rd percentiles of all U.S.-listed stocks, respectively. However, it ranks poorly in terms of its accruals to assets, in the 13th percentile.
Earnings estimate revisions offer an indication of how analysts are viewing the short-term prospects of a firm. The company has an Earnings Estimate Revisions Grade of B, which is considered positive. The grade is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Wells Fargo reported a positive earnings surprise for fourth-quarter 2021 of 10.8%, and in the prior quarter reported a positive earnings surprise of 22.9%. Over the last month, the consensus earnings estimate for full-year 2022 has increased 7.7% to $3.88 per share based on 20 upward and only two downward revisions.
Wells Fargo has a Momentum Grade of A based on its Momentum Score of 91, and a weak Growth Grade of D. The company has a current dividend yield of 1.5%.