Big Trouble for Big Bank Stocks

Big banks like JPMorgan can't cut their way to sustained growth

Big Trouble for Big Bank Stocks

Earlier this week JPMorgan (JPM) announced it would be cutting another 8,000 jobs in 2014. Most of the cuts are in the mortgage business, as demand for refinancings and new home mortgages have declined recently.

And JPMorgan’s announcement is just the latest round of cuts to hit the banking space. Last week Bank of America (BAC) announced it would be laying off people in its bank operation departments in Charlotte. Wells Fargo (WFC) has been cutting back on its mortgage operations in the past year. The trend is not confined to the U.S. either, as both Barclays (BCS) and Royal Bank of Scotland (RBS) have announced layoffs in the past few weeks.

I highly doubt that these banking jobs will ever come back. Banks were bloated with personnel coming into the financial crisis — and in their mad rush to improve balance sheets and cut costs, all of the major banks have had several huge rounds of layoffs. Well over 100,000 jobs have been lost as a result of the cost-cutting programs. As the economy continues to struggle to show sustained growth, I doubt the banks will begin to rehire and rebuild personnel headcount anytime soon.

What’s more, we may be seeing just the first wave of the storm.

Like many other industries, banks are finding out that it is easier to do more with fewer people thanks to technology. They need fewer people in the back office to process transaction and handle documents. Many of the marketing functions that once required a large sales and marketing department can now be moved to a much smaller (and more cost-effective) online presence. Bank mergers are creating overlap, and redundant employees are being shown the door.

The mortgage business is changing dramatically amid new regulations, and there are very few specialty products that can be sold by brokers. Mortgages are becoming commoditized to a very high degree — and the sales and marketing process requires fewer people to sell and process new business. Commodity products do not require a large and costly sales force, and much of the sales process can also be moved online as a way to produce new business more efficiently and at greater cost savings.

It is highly unlikely that we will see the banks become a source of job creation in the future. They are doing more with less, and new regulations have forced them to cut back on many of the products and services they once offered. The only job growth in the industry will be in the compliance and IT departments.

So, what does all this mean for bank stocks going forward?

The bigger banks have wrung earnings growth over the past few years through these cost-cutting moves (as well as reserve releases, balance sheet adjustments and stock buybacks). The financial sector grew its fourth-quarter earnings by nearly 25% year over year — the biggest gain among S&P 500 sectors. But bear in mind that the revenue comparison for the year is actually negative when compared to 2012.

Simply put, there is very little opportunity for growth in the banking sector right now. The restrictions and costs of legislation like Dodd-Frank have had a negative effect on the larger banks’ earnings potential. Loan demand is still very weak, as the economy is still growing at a very slow pace compared to previous recoveries.

For large-cap bank stocks to grow, they need to show real, sustained revenue growth. They will continue to cut staff … but not in large enough numbers to have the same impact on earnings as the recent past. Loan-loss reserves have been drawn down and regulators are going to be wary about allowing banks to draw down much more to increase earnings.

In fact, I suspect the bigger banks will start to face increased competition from the larger regional banks. Banks like BB&T (BBT) and PNC Financial (PNC) can grow by acquisition in the current environment — not really a strong option for the money center banks. Big bank stocks could be stuck here until the economy allows them to grow revenues — and not just engineer profits.

At the time of publication, Melvin was long WFC.


Article printed from InvestorPlace Media, http://investorplace.com/2014/02/big-trouble-big-bank-stocks/.

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