Large Bank Earnings: Good (WFC), Bad (C, JPM), and Very Ugly (BAC)
The cascade of US bank earnings reports are painting a picture that shows increasing divergence between institutions of different sizes and business models. As with 2010, the first quarter of this year looks to be the best quarter for 2011, particularly for the largest commercial banks. Click here to see the distribution of IRA bank ratings for the entire industry. We had 3,700 banks rated “A+” at the end of Q1 2011 vs. 2,900 at the end of 2009.
In general, the financial condition of the commercial banking industry is improving, with smaller and regional institutions showing dramatically better operating results, but some larger banks still suffering ill-effects of legacy liabilities from the mortgage sector. Investment banks such as Goldman Sachs and Morgan Stanley, on the other hand, show significant deterioration in operating results, an unfortunate side effect of the slowing US economy.
Perhaps the most shocking if not surprising results came from Bank of America (“BAC”/Q1 2011 IRA Bank Stress Rating: “B”), which reported an enormous loss related to the bank’s huge mortgage lending and servicing portfolio as well as lower revenue. The negative trend in BAC’s financial results over the past several quarters is deeply troubling and, as we have long predicted, may suggest an approaching Dodd-Frank restructuring is in the cards.
The IRA bank stress rating reflects the current results of BAC and other banks with respect to equity returns, capital adequacy, credit losses, unused lending capacity and efficiency. The Q2 2011 rating for BAC, which will be out in a couple of weeks and is based on data from the FDIC, is likely to be significantly degraded from the “B” grade of last quarter, up from a “C” in Q1 2011.
Among the large banks, the best results so far have come from Wells Fargo (“WFC”/Q1 2011 IRA Bank Stress Rating: “A”), which reported strong earnings and relatively good revenue, albeit with sharply lower new loan origination volumes. WFC recently announced a settlement of $35 billion securities fraud claims that, when finalized, will reflect a significant reduction in the bank’s exposure to its trillion dollar loan servicing book, the second largest after BAC.
The Q2 2011 earnings for JPMorgan Chase ("JPM"/Q1 2011 Bank Stress Rating: "B") are about what my firm told clients to expect, with deposits swelling under pressure from the global capital flight visible in the EU interbank market. Loans net of loan loss provisions are about flat, but provisions for future losses dropped another $1 billion plus since last quarter.
Even with the balance sheet growth, the average yield on earning assets at JPM dropped to 3.58% from 3.74% in Q1 2011. Investment banking and principal transactions are still leading the way on revenue, but JPM could not repeat the record $4.7 billion in principal transaction gains from Q1 2011. This is not a bad quarter by any means, but it does beg the question with respect to expenses. JPM’s efficiency ratio of 63% is up five points from Q2 2010 and is likely to go higher during the balance of 2011.
If there is no real growth on the loan origination line, then JPM must make the earnings number from investment banking and principal transactions. My firm downgraded JPM’s outlook on forward operating results earlier this year due to concerns about RMBS and HELOC exposures, none of which are addressed in the Q2 results. Unlike WFC, JPM has yet to announce any settlements of either foreclosure, securities fraud or other claims. The Bear, Stearns-related legal claims facing JPM are particularly nasty, with lawsuits pending seeking damages that are well into double digits billions.
Unfortunately most people in the media cannot actually read a financial statement, so the reaction to the JPM results were exuberant. As with the news reports on JPM, the media response to the Citigroup ("C"/Q1 2011 Bank Stress Rating: "C") earnings was a tad more effusive than was really justified.
The Big Media's fixation with the fact that the bank beat Sell Side "expectations" is bad enough, but virtually none of the news organs bothered to notice that C backed another $1.7 billion out of loss provisions to boost earnings. Without this aggressive accounting treatment, C's income would have been $1.6 billion, not $3.3 billion. Somebody please break the bad news to my friend Eric Dash at the NYT.
Expenses at C rose $500 million in the quarter and net credit losses continue to fall, but down only 27% compared to the 50% plus reserve reversal. Non-accrual assets are down two points from March 2010, but let's hope that non-accruals remain low. We are very pleased to see the $20 billion handle on the C revenue line, but this still amounts to down 7% for revenue in the first six months of 2011 vs. 2010.
As in the case of JPM, the return on earning assets for Citicorp fell almost a quarter point sequentially, grim evidence that the Fed’s zero rate policy is starting to seriously impact bank revenue and earnings. Notice that as with JPM and many other banks, the growth in C's deposit base since the start of 2010 came almost entirely from non-interest bearing deposits.
Overall, C earnings were down 11% YOY for first six months, even through the quarterly comparison looked good after the poor Q1 2011 results. As former FDIC Chairman Sheila Bair said earlier this year, banks can't enhance earnings by backing reserves back into income forever, a comment that could have been aimed squarely at CEO Vikram Pandit Alas, we may never know. But apparently C did not think one more quarter of using provisions releases to hit the numbers would hurt.