Bank of America Corporation (NYSE: BAC), Citigroup Inc. (NYSE: C) – Brighter horizons? Big banks still struggling as Q4 earnings approach, but calmer waters are seen
The headwinds that have been blowing regularly on the big banks for nearly a year are easing a bit, just in time for earnings season.
As we approach Friday’s fourth quarter earnings reports from JPMorgan Chase & Co. (NYSE: JPM), Citigroup Inc (NYSE: VS) and Wells Fargo & Co (NYSE: WFC), the deadly combination of ultra-low interest rates, credit worries, a sharp economic downturn and strict government regulations that kept banking performance in check for most of 2020 has not entirely disappeared. , but could relax.
A sign came last month when the Fed lifted some restrictions on stock buybacks for banks, in part thanks to their strong performance in recent stress tests. This has bolstered what appears to be the relative health of the industry after last year when big banks had to set aside huge sums of money to make up for possible credit losses.
Some banks reacted quickly to the Fed’s announcement by announcing new share buyback programs, helping to revitalize the declining industry. At the same time, Treasury yields rose throughout the fourth quarter, perhaps helping banks improve their profit margins. Another boost in the fourth quarter was the warm initial public offering (IPO) market. It can be a profitable business for large investment banks.
What to look out for at the start of profit season
Despite all this, a few clouds persist. The fourth quarter likely continued to weigh on bank profits to some extent, in part due to economic shutdowns that appeared to hurt the economy during that time. More consumer-focused banks may suffer more than investor-focused and M&A-focused banks.
This means that it would be useful this earnings season to have a sense of the state of banks’ commercial lending activities. Keep an eye on their lines of business, including credit cards, auto loans, mortgage books, industry loans, and personal loans. It is important not to think of this as a homogeneous pile of loans, but to sort it out and see how the different ones are doing to get an idea of how the various aspects of the economy are performing.
Another big question ahead of the fourth quarter results is whether banks can reduce some of the reserves they built up for a possible credit loss when the pandemic hit the economy. These measures reduced profits for most of 2020.
All S&P 500 Financial (IXM) would experience a 7.8% loss in year-on-year earnings per share in the fourth quarter, according to research firm CFRA. That’s an improvement over the company’s estimate for an overall financial sector revenue loss for 2020 of 22%, so maybe things are looking up. Looking ahead, the CFRA expects financial profits to increase 17.8% in the first quarter.
FIGURE 1: Q SOLID FOR FINANCIALS. Financial stocks (IXM — candlestick) easily outperformed S&P 500 Index (SPX — purple line) over the past three months, which is roughly most of Q4. This comes after financials typically lagged the broader index for most of 2020. Data source: S&P Dow Jones Indices. Chart source: The TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance is no guarantee of future results.
“We believe consumer and commercial lending activity as well as credit risk is expected to improve in 2021 from the abyss in 2020,” the CFRA said in a note. “Yes, bank stocks are cyclical and we are all seeing the boats come out of the economic recovery. This sub-sector has successfully managed the ongoing credit risks due to the impact of Covid-19, and we believe the largest banks were fundamentally strong enough to absorb the economic shock of a healthcare crisis. and may have overbooked for loan losses. “
JP Morgan tries to follow strong third quarter
JPM CEO Jamie Dimon is arguably one of the deans of Wall Street, and his remarks about the transition to Washington – if he thinks about it – could be of use to investors as they position themselves for the future. . What, if any, is he worried about new regulatory burdens and potential taxes for the industry?
Other things to listen to include his take on the disappointing December job growth figure, if he thinks the Fed is going to be under pressure to withdraw its monetary stimulus program to buy bonds, and how long he thinks it would take the economy to rebound back once the virus subsides.
Another question is whether the slow but steady rise in Treasury yields has started to help the company record better profits. Earlier this week, 10-year yields rebounded above 1.15%, from historic lows of around 0.5% at the start of August. Higher yields generally contribute to the profit margin of large banks, and the yield curve (the premium of long-term yields over short-term yields) continues to steepen after turning negative by a few points over the years. last two years. All of this could point to better times for JPM and other banks.
JPM built up a huge cushion of reserves against possible credit losses when the pandemic hit, and now investors will likely be curious to see how the company proceeds. The last time it released its report in October, JPM actually reduced its loan loss reserves slightly. The company beat Wall Street earnings and earnings estimates in the third quarter amid better-than-expected business activity, and the stock began what is now a nearly three-month rally, dropping from under $ 100 at the end of October to over $ 139 at the start of this week.
Last time around, Dimon noted that the bank’s total reserve size for loan losses was still rounded to $ 34 billion, roughly the same as in the previous quarter, CNBC reported. In the third quarter earnings release, he cited the need to maintain reserves “given significant economic uncertainty and a wide range of potential outcomes” related to the pandemic. Investors may want to closely monitor any changes to that language on Friday, as well as whether JPM believes there is less risk of default at this point.
Focus on consumers as reported by Citigroup
C benefited from better than expected business results in the third quarter, so investors are looking to see if this continued into the fourth quarter.
In addition, C is often considered a good consumer barometer thanks in part to its significant credit card business. Whether it’s good or bad this time around depends on the health of the consumer, and the fourth quarter was not particularly strong from an employment perspective.
New weekly unemployment claims have remained stubbornly above 800,000, more than three times the rate people were used to before 2020. The economy lost 140,000 jobs in December, according to the Labor Department. Retail sales for December are released on the same day as C’s earnings, giving a better look at consumer habits.
C has also developed its investment banking activities and could benefit from a strong recovery in initial public offerings (IPO) recently, as well as some news on mergers and acquisitions (M&A). Typically, rising IPOs and mergers and acquisitions are good barometers for an improving economy.
“We had a record number of IPOs in the third quarter – 208 – and activity remained strong in the fourth quarter with 168 IPOs recorded,” research firm FactSet wrote in a note last week. . “As fourth quarter activity was below the frantic pace of the third quarter, companies raised $ 53.8 billion.”
Getting back to the trading room, the huge surge in equities in the fourth quarter and bond selloff likely benefited banks as overall activity looked excellent.
When it comes to net interest income, a key data point for banks, most investors keep an eye on the 10-year / two-year US Treasury yield spread. Not so much for C because its loan portfolio is heavily exposed to Europe. This means that the 10/2 bund spread is more of a factor.
After rates tumble at WFC in the third quarter, what’s next for the fourth quarter?
WFC was the only bank whose results disappointed Wall Street on the first day of the third quarter earnings season. At the time, WFC executives attributed their weak quarter in part to historically low interest rates. The company suffered a sharp decline in net interest income in the third quarter compared to the previous year.
Rates remain very low today, but have improved markedly in the fourth quarter. The question is whether WFC can find enough other things to get its head out of the water.
WFC has the largest mortgage origination company of the three banks we are talking about here. As we have noted in the past, WFC’s CFO has called mortgages the “core” of the company’s business.
The National Association of Realtors said last month it expected home purchases in the United States to reach 5.52 million in 2020, the highest annual record since 2006, with the median home price reaching a record $ 293,000. The housing market also looks set to continue to sizzle going forward thanks in part to low inventories which could boost home construction and keep prices on the rise.
All of this would likely be good news for WFC, and a key thing to listen to when they call is how leadership sees this aspect of the economy evolving in 2021.
Like other banks, it is important to check and see how WFC is preparing for possible credit losses and whether it is ready to start cutting some of the reserves it has set aside for this purpose.
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