The coming and going of Alibaba’s recent IPO were like the rumblings of King Kong’s footsteps as he walks past you in the jungle. But now that the shaking and quaking has dissipated and the markets are slowly returning to normal, all the other IPO’s of the investment jungle can come out of their hiding places and forage for food once again.
One of them is the Royal Bank of Scotland’s Rhode Island-based subsidiary Citizens Financial Group, which is looking to raise some $3.01 billion today in the third largest U.S. bank IPO in 15 years since CIT Group raised $4 billion in 2002, and Goldman Sachs raised $3.66 billion in 1999.
While this may be a big win for troubled RBS which was recently bailed out by the U.K. government and has been under pressure to divest some of its assets including Citizens Financial, the IPO isn’t going to be as sweet as it was once thought to be. As the Wall Street Journal informs, “interest was muted”, forcing Citizens Financial to lower its asking price going into last night’s deadline.
Are cracks starting to form in the U.S. financial sector? After scoring the second best Q2 earnings ever, some analysts feel financial stocks may have peaked for now. What will it take to lift them on their next leg up? Should you invest in the banks at this point, or wait for better opportunities later?
CFG – Signal to Buy or Sell?
The original expectation of Citizens Financial Group was to offer its 140 million shares for between $23 and $25 a piece, for a total take of $3.22 to $3.5 billion. But late last night the firm had to lower its asking price to $21.50 for a lesser take of just $3.01 billion, some 11.6% below the original midpoint price.
Yet if U.S. banks as a whole just scored their second highest quarterly earnings in history this past Q2, why is interest in CFG so weak?
“Behind a tepid reception for the offering, investors and analysts pointed to a lackluster year for bank stocks and valuations on the new shares that many said were rich,” answers the Wall Street Journal. “The lukewarm reception for the Providence, R.I., regional lender underscores the mixed performance of financial shares in what has otherwise been a solid year for U.S. shares and a strong one for IPOs.”
Looking at those lackluster stock performances of U.S. banks in the graph below reveals that after stellar gains since the economic recovery began in early 2009, the sector may have peaked for the second time. A familiar pattern seems to be repeating itself.
As noted above in red, Bank of America (NYSE: BAC) (purple), JP Morgan Chase (NYSE: JPM) (blue), Goldman Sachs (NYSE: GS) (beige), and the SPDR Financial Sector ETF (NYSE: XLF) (orange) have been trending sideways since the start of this year. It seems the long rise out of the 2011 correction (brown) has finally stalled.
This is a pattern we have seen before (green), when the financial sector rose sharply immediately after the 2008-09 crash, only to flounder sideways for nearly two years until mid-2011. How did that flight finish? In another spectacular crash in the second half of 2011.
Is this the way the current cycle is going to end? After climbing as high as they could this time around, are the financials heading for another crash and burn?
Saving U.S. Banks – Again
Saving the U.S. financial sector from a repeat of the last two crashes – the larger one in 2008-09, and the lesser one in 2011 – will require another intervention by the U.S. Federal Reserve. But before taking to the streets in protest of another bank bailout, it will sooth us to know that another bailout is not on the Fed’s mind.
Indeed, the first two times the Fed helped the financial sector was with truck loads of cheap money. In the first rescue in 2009, the Fed stepped in with cash infusions know as Quantitative Easing, and ultra-low interest rates near zero. Hence the immediate rise like a moonshot later that year.
But the adrenaline rush of that first bank rescue didn’t last long, as the banks quickly plateaued and were once again routed in 2011. This forced the Fed to step in again.
In the second rescue in 2012, the Fed stepped in with QE3 – monthly purchases of mortgage-backed securities from the banks. Buying these mortgages from the banks refilled their vaults with cash which they could use to keep issuing more mortgages and keep making profit.
All the while, the Fed kept interest rates for the banks near zero, allowing the banks to make a tidy profit as they borrowed money for next to nothing and then loaned it out for 3% to 4% in new mortgages.
This round of stimulus has now run its course with the Fed’s winding down of its monthly purchases of mortgage-backed securities which is due to be terminated this quarter, contributing to the flattening of banking stocks.
So is another bank rescue forthcoming? Yes and no. “Yes” in that the Fed is going to help the banks again, but “no” in that it will not be with another stimulus package.
Third Time Lucky
In order to stop this vicious cycle of rescue, soar, plateau, crash, and rescue again is going to require something different. We need to get to the heart of the banks’ inability to sustain itself. They have become too reliant on Fed assistance, and after a short time are once again at the Fed’s doorstep with outstretched palms.
What exactly is at the core of the problem? “Banking-industry revenue has been pressured by low interest rates and new rules that restrict consumer fees and client trading,” answers the Wall Street Journal, “and shares of many banks have lagged behind broad indexes” as a result.
This is why the first two rescues of 2009 and 2012 did not last long. Stimulus was just a temporary soup kitchen for the banks. But once each stimulus program ended, the banks would soon go hungry again, as interest rates were much too low to generate enough revenue. What they need are a way of earning their own bread and butter, and that will require interest rate hikes back to healthy levels.
Once the Fed embarks on the journey back to normal interest rates, banks and other lending institutions will be able to generate more profit from their loans and mortgages, enabling them to carry themselves forward without financial assistance from Papa Fed.
Luckily for the banks, they won’t have to wait long, as interest rates are expected to rise some time in late 2015 or early 2016. But the question is, can they hold out until then? Remember how long the plateau lasted the first time? About two years, from mid-2009 to mid-2011.
The banking sector just recently peaking in Q2 of this year means it should be able to hold out until the end of 2015 or early 2016 at the latest before losing its momentum. It’s going to be close, but it looks like they’ll make it the rest of the way.
The question for investors, however, is should we be investing in the banking sector before rates start to rise? By the look of things, probably not. There is nothing on the horizon that would give the banks any upward lift into another up-leg.
It will take either another round of stimulus or a rise in interest rates for another spurt up in bank stocks. We all know the former won’t be happening again, while the latter isn’t going to happen for at least another full year.
Until then, banks are not the place to be.