It was the best of times, and it was the worst of times for the banking sector in 2013. The Big Four as well as regional banks made strong gains as they have recovered from the financial crisis of 2008 and returned to profit making. But there were stiff headwinds on the road to recovery.
Lawsuits and regulatory enforcements hamper money center banks
The Big Four U.S. banks were hit with waves of legal cases and regulatory enforcement actions. And these cases had a cumulative adverse impact on banks' earnings by end of the third quarter. In particular, JPMorgan Chase (JPM 2.51%) reported a rare loss due mostly to set-asides to cover the $13.5 billion settlement with the Justice Department and federal regulators that was finalized in the fourth quarter.
For the third quarter, the big bank reported a net loss of $0.4 billion compared to net income of $5.7 billion for the similar time period in 2012. CEO Jamie Dimon said legal costs could remain "volatile" over the next several quarters.
While JPMorgan has cleared this hurdle, there are other legal hassles on the horizon for the Big Four, such as the probe into the LIBOR rigging scandal, which will resurface in 2014.
So what's an investor in the banking sector to do?
There are no safe harbors from these legal and regulatory matters, but one alternative is to give regional banks a look. However, this sector has also faced net interest margin pressures spurred by the Federal Reserve's long-standing quantitative easing and fractional interest rate monetary policies. That being said, there are good regional bank picks for the coming year.
One solid dividend yield
New York Community Bancorp (NYCB) operates two main bank subsidiaries, New York Community Bank and New York Commercial Bank. Also, during the second quarter, the NYCB Specialty Finance Company was added to its lending arm, and management expects an increase in lending activity in the upcoming quarters through this channel.
The regional banking firm originates mortgages primarily on multi-family dwellings with strict underwriting standards. The bank is strong in many ways, including its conservative loan portfolio as well as a healthy dividend yield -- currently 6%, and this is a key factor for investors in search of dividends.
However, according to the third-quarter report in November, the company generated earnings of $114 million compared to $122.5 million in the three months ended June 30, 2013. Management attributes the downtick in earnings to declines in mortgage banking income. This was a result of a sharp drop in demand for one-to-four family loans because of rising residential mortgage interest rates in 2012. Finally, the banks' net interest margins, its primary source of income, have come under pressure as the Federal Reserve has kept interest rates at record low levels for four years now.
A going loan portfolio
Valley National Bankcorp (VLY 5.47%) provides customers commercial, retail, trust, and investment services. Valley has a solid core because of it depositary banking unit, which offers an array of traditional deposit products like savings accounts, NOW accounts, money market accounts, and certificates of deposit.
The outfit has a market cap of just over $2 billion with about $16 billion in assets including Valley National Bank, its main subsidiary. The company's current dividend yield had been robust (6.62%) until the bank recently announced it was reducing its cash dividend by over 30% (from $0.16 per quarter to $0.11 per quarter).
But this is no reason for long-term investors to panic as the move is designed to make cash available to cover tighter capital requirements. Also, the bank's loan portfolio grew at an annualized rate by about 19% or $514 million in the third quarter from the second quarter of 2013. Valley National's management said it is "cautiously optimistic" it will continue to grow its loan portfolio, which can be a countervailing force against net interest margin pressure.
The bottom line
The regional banks' future earnings in the coming year are subject to a number of variables. Net interest margin pressure should abate if and when the Federal Reserve begins the overdue tapering of its easy money policy. And a return to normalcy in the housing market could spur home lending activity.
In short, New York Community Bancorp's attractive dividend yield and Valley Bank's loan originations outlook make these banks a good play for investors with a long-term view. Finally, the LIBOR rigging scandal could send another shock wave at the money center banks, so caveat emptor.
