JPMorgan shares have 20% upside: analyst
Analysts say banks with strong capital markets business and those that will benefit from an improving economy may be solid investments.
As investors weigh the benefits of rising rates for financials, banks with strong capital markets businesses like JPMorgan Chase (JPM) and those that will benefit from an improving economy may be better investments, say analysts.
"Contrary to popular belief, bank earnings are much more levered to higher short-term rates than they are to higher long-term rates," KBW banks analyst Christopher Mutascio wrote in a research note. "We don't see this catalyst playing out for a long time to come."
He points out that higher long-term rates with no follow-through rise in short-term rates could mean the modest benefit to net interest income from deploying excess liquidity into higher-yielding investments could be offset by lower mortgage banking income as refinancing volumes dry up.
But other analysts say the rise could be positive, at least in the beginning.
"The initial rise in rates is very favorable to banks because it widens their spread. But if that rise in rates turns out to be parabolic and the losses in their bond portfolios become much greater than anticipated, that rise in rates turns negative," Gerard Cassidy, an analyst at RBC Capital Markets, told CNBC. "We're not there yet, but it's something we're watching."
For Wells Fargo (WFC), which has a large mortgage business, lower mortgage banking revenue means that earnings growth could be more challenging. And with little reason to hike earnings estimates, KBW's Mutascio downgrades the stock to "market perform" after its recent run up.
Mutascio said the multiple would have to expand for the stock to trade higher. But already trading at a premium to its long-term average, that's a tall order.
"In the current environment where revenue growth and pretax, pre-provision earnings growth is tough to come by [even for a strong franchise like Wells Fargo] and re-regulation continues to impact the largest banks, we are hesitant to raise target prices on multiple expansion alone and are unwilling to apply premium multiples to historical valuations," Mutascio wrote.
If Wells Fargo looks fairly valued, Raymond James sees reason to upgrade JPMorgan to "strong buy" ahead of the bank's earnings next Friday.
Analyst Anthony Polini bases the upgrade on "a more favorable outlook for EPS growth and diminished concerns for residual risk from the London Whale incident."
Polini as well as RBC's Cassidy see a strong quarter for the bank's capital markets business.
Polini hikes his 2013 and 2014 earnings forecasts to $5.75 and $6.00, respectively. His new $64 price target, implies 21 percent upside from current levels.
"We want to own the banks that are doing better because the underlying economy is doing better," he said. "Regional banks are certainly a way to play that with the housing market recovering the way it's recovering today."
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