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Banks set to kick off US Q3 earnings season
The S&P 500 rose 8.5% to 3,363 over the third quarter, having hit an all-time of 3580 at the start of September, with an intraday peak at 3588. The market faced ongoing headwinds from the pandemic, but risk sentiment remained well supported through the quarter by fiscal and monetary policy.
A pullback in September erased the August rally but was largely seen as a necessary correction after an over-exuberant period of speculation and ‘hot’ money into a narrow range of stocks.
Q3 earnings come at important crossroads: Expectations for when any stimulus package will be agreed – and how big it should be – continue to drive a lot of the near-term price action, though the market has largely held its 3200-3400 range.
Elevated volatility is also expected around the Nov 3rd election. But next week we turn to earnings and the more mundane assessment of whether companies are actually making any money.
Banks kick off Q3 earnings season
Financials are in focus first: Citigroup and JPMorgan kick off the season formally on October 13th with Bank of America, Goldman Sachs and Wells Fargo on the 14th. Morgan Stanley reports on Oct 15th, In Q2, the big banks reported broadly similar trends with big increases in loan loss provisions offset by some stunning trading earnings.
Wall Street beasts – JPM, Goldman Sachs, Citi, Morgan Stanley and Bank of America – posted near-record trading revenues in the second quarter with revenues for the five combined topping $33bn, the best in a decade. At the time, we argued that investors need to ask whether the exceptional trading revenues are all that sustainable, and whether there needs to be a much larger increase for bad debt provisions.
Meanwhile, whilst the broad economic outlook has not deteriorated over the quarter, it has become clear that the recovery will be slower than it first appeared. Moreover, during Q3 the Fed announced a shift to average inflation targeting that implies interest rates will be on the floor for many years to come, so there is little prospect of any relief for compressed net interest margins.
Meanwhile there is growing evidence of a real problem in the commercial mortgage-backed securities (CMBS) market as new appraisals are seeing large swatches of real estate being marked down, particularly in the hotels and retail sectors.
At the same time, the energy sector has gone through a significant restructuring as we have seen North American oil and gas chapter 11 filings gathering pace through the summer as energy prices remained low. There is a tonne of debt maturing next year but how much will be repaid?
Key questions for the banks
- Did the jump in trading revenues in Q2 carry through in Q3? Jamie Dimon thought it would halve.
- On a related note, did the options frenzy in August help any bank more than others – Morgan Stanley?
- Have provisions for bad loans increased materially over the quarter?
- How bad are credit card, home and business loans?
- And how bad is the commercial property sector, especially hotels and retail as evidence from the CMBS market starts to look very rocky?
- How are bad debts in oil & gas looking?
- How are job cuts helping Citigroup lower costs; how will its entry into China make a difference to the outlook?
- How does Wells Fargo manage without an investment arm to lean on? So far it’s been a bit of a mess.
- Was Warren Buffett right to cut his stake in Wells Fargo and some other US banks? Buffett pulled out airlines first then banks.
- What do banks think of never-ending ZIRP and does the Fed’s shift affect forecasts at all?
- How is Morgan Stanley’s wealth management division cushioning any drop in trading revenues?
- What progress on Citigroup’s risk management system troubles?
Q2 earnings recap
JPMorgan beat on the top and bottom line. Revenues topped $33.8bn vs the $30.5bn expected, whilst earnings per share hit $1.38 vs $1.01 expected. The range of estimates was vast, so the consensus numbers were always going to be a little out.
The bank earned $4.7bn of net income in the second quarter despite building $8.9 billion of credit reserves thanks to its highest-ever quarterly revenue. Loan loss provisions were $10.5bn, which was more than expected and the quarter included almost $9bn in reserve builds largely due to Covid-19.
The consumer bank reported a net loss of $176 million, compared with net income of $4.2 billion in the prior year, predominantly driven by reserve builds. Net revenue was $12.2 billion, down 9%. Credit card sales were 23% lower, with average loans down 7%, while deposits rose 20% as consumers deleveraged.
The provision for credit losses in the consumer bank was $5.8 billion, up $4.7 billion from the prior year driven by reserve builds, chiefly in credit cards.
Trading revenues were phenomenal, rising 80% with fixed income revenues doubling. Return on equity (ROE) rose to 7% from 4% in Q1 but was still well down on the 16% a year before. ROTE rose to 9% from 5% in the prior quarter but was down from 20% a year before.
Citigroup EPS beat at $0.50 vs the $0.28 expected. Trading revenues in fixed income rose 68%, and made up the majority of the $6.9bn in Markets and Securities Services revenues, which rose 48%. Equity trading revenue dipped 3% to $770 million. Consumer banking revenues fell 10% to $7.34 billion, while net credit losses, jumped 12% year over year to $2.2 billion. Net income was down 73% year-on-year.
Since then the bank has offloaded its retail options market making business, leaving Morgan Stanley (reporting Oct 15th) as the major player left in this market. We await to see what kind of impact the explosion in options trading witnessed over the summer had on both. ROE stood at just 2.4% and ROTE at 2.9%.
Wells Fargo – which does not have the investment banking arm to lean on – increased credit loss provisions in the quarter to $9.5bn from $4bn in Q1, vs expectations of about $5bn. WFG reported a $2.4 billion loss for the quarter as revenues fell 17.6% year-on-year.
CEO Charlie Scharf was not mincing his words: “We are extremely disappointed in both our second quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter, which drove the $8.4 billion addition to our credit loss reserve in the second quarter.”
Bank of America reported earnings of $3.5 billion, with EPS of $0.37 ahead of the $0.27 expected on revenues of $22bn. Its bond trading revenue rose 50% to $3.2 billion, whilst equities trading revenue climbed 7% to $1.2 billion. But the bank increased reserves for credit losses by $4 billion and suffered an 11% decline in interest income.
Return on equity (ROE) fell to 5.44% from 5.91% in the prior quarter and was down significantly from last year’s Q2 11.62%. Return on tangible equity (ROTE) slipped to 7.63% from 8.32% in Q1 2020 and from 16.24% in Q2 2019.
Morgan Stanley was probably the winner from Q2 as it reported net revenues of $13.4 billion for the second quarter compared with $10.2 billion a year ago. Net income hit $3.2 billion, or $1.96 per diluted share, compared with net income of $2.2 billion, or $1.23, for the same period a year ago.
Wealth Management delivered a pre-tax income of $1.1 billion with a pre-tax margin of 24.4%. Investment banking rose 39%, with Sales and Trading revenues up 68%. MS managed to increase its ROE to 15.7%, and the ROTE to 17.8% from respectively 11.2% and 12.8% in Q2 2019.
Goldman Sachs reported net revenues of $13.30 billion and net earnings of $2.42 billion for the second quarter. EPS of $6.26 destroyed estimates for $3.78. Bond trading revenue rose by almost 150% to $4.24 billion, whilst equities trading revenue was up 46% to $2.94 billion. ROE came in at 11.1% and ROTE at 11.8%.
|Bank||Forecast Revenues (no of estimates)
|Forecast EPS (no of estimates)
|BOA||$20.8bn (8)||$0.5 (23)|
|GS||$9.1bn (15)||$5 (21)|
|WFG||$17.9bn (17)||$0.4 (24)|
|JPM||$28bn (19)||$2.1 (23)|
|MS||$10.4bn (15)||$1.2 (20)|
|C||$18.5bn (17)||$2 (21)|
None have really managed to match the recovery in the broad market but valuations are compelling.
Goldman trading either side of 200-day EMA
Wells Fargo can’t catch any bid
Bank of America bound by 50-day SMA
Citigroup still nursing losses after reversal in September
JPM breakouts consistently fail to hold above 200-day EMA
JPM shares rise on record trading revenues
Extrapolating too much from a single bank’s earnings is always an easy trap to fall into … but the quarterly numbers from JPMorgan indicate Main Street is not doing nearly as well as Wall Street – this is not a surprise, but it begs the question of when the credit losses from bad corporate and personal debt starts to catch up with the broader market. Moreover, investors need to ask whether the exceptional trading revenues are all that sustainable.
JPM rose in pre-market trade – the shares of JPM and other investment banks (C, GS, MS, BAC) can rally from this because they are relatively cheap and have not participated in the rally since March in the same way as the broad market. However, the implications for the broader market are interesting – do impairments matter for the rest of the market, for consumer cyclicals for example? Given the way the investment bank is doing all the lifting, what are the implications for financials like the XLF ETF? Or Russell 1000 financials? The outlook there must be a lot more challenging.
JPMorgan beat on the top and bottom line. Revenues topped $33.8bn vs the $30.5bn expected, whilst earnings per share hit $1.38 vs $1.01 expected. There was a huge range of estimates so the consensus numbers were always going to be a little out.
The bank earned $4.7bn of net income in the second quarter despite building $8.9 billion of credit reserves thanks to its highest-ever quarterly revenue.
Loan loss provisions were $10.5bn, which was more than expected and the quarter included almost $9bn in reserve builds largely due to Covid-19. The company reaffirmed suspension of share buybacks at least through the end of Q3 2020.
The consumer bank reported a net loss of $176 million, compared with net income of $4.2 billion in the prior year, predominantly driven by reserve builds. Net revenue was $12.2 billion, down 9%. Credit card sales were 23% lower, with average loans down 7%, while deposits rose 20% as consumers deleveraged. The provision for credit losses in the consumer bank was $5.8 billion, up $4.7 billion from the prior year driven by reserve builds, chiefly in credit cards.
Trading revenues were phenomenal, rising 80% with fixed income revenues doubling, which indicates the investment banks on Wall Street are in good shape thanks largely to their trading arms. But the numbers elsewhere don’t suggest Main St is in good shape at all, which indicates the more diversified investment banks are going to be in better shape than many others. As we discussed in the preview to this week, the massive about of investment grade corporate bond issuance and mortgage refinancing as companies and household refinanced to take advantage of lower rates has been a big help, albeit far bigger than we had thought. Assets under management rose 15% but this probably broadly reflects the rally in the equity markets since the last earnings release.
My sense is what while the stock market does not reflect the real economy, and the JPM numbers reinforce this view, this is not a barrier to further gains. The vast amount of liquidity that has been injected into the financial system will keep stocks supported – the cash needs to find a home somewhere and bonds offer nothing. However there is clearly a risk that Main Street starts to bite at the ankles of Wall Street and results in another pullback like we saw in the second week of June. We should remember that there could some very hard yards ahead for the US economy as states pause reopening – loan loss provisions may need to rise a lot more.
Meanwhile Delta Airlines reported an ugly loss of $4.43 vs $4.07 expected, though revenues were a little ahead of forecast. Net loss of $3.9bn with Q2 revenues the lowest since the mid-80s. It has the cash to last 19 months despite burning through $27m a day in cash – down from $100m at the peak of the crisis.
Wells Fargo and Citigroup coming up next….
Dow earnings kick off, European markets pare gains, gold hits fresh high
European markets still traded broadly higher into lunch but failed to make much headway in a pretty lacklustre session. The FTSE 100 failed the test at 5900 and retreated to 5800 where it found support. Bear in mind this comes after a near 4% gain in the last trading session on Thursday. The DAX was off its highs but still traded up 1% for the session. As of send time, Wall Street is more positive and the Dow was looking to open about 300 points higher.
Meanwhile corporate earnings kicked off today with two Dow components first on the slate. Johnson & Johnson raised its dividend but lowered its guidance for 2020 to reflect the Covid-19 impact. The dividend was raised by 6.3% to $1.01 on adjusted earnings per share of $2.30 vs $2.01 forecast.
JPMorgan EPS came in a 78 cents vs $1.84 expected and $2.57 a year ago. The key thing was credit costs – provisions for losses jumped to $8.3bn, which was double the median estimate, although it was a lot lower than the $25bn that one analyst forecast. Last year the number was $1.3bn. The bank is preparing for a severe recession and needs to set aside capital to cover expected losses – problem is no one has a clue how big these might be. I should stress that even the cleverest banks won’t know just what the damage will be in a situation where the economy is stopped and then restarted. No big surprise to see a big improvement in trading revenues whilst similarly the drop in investment banking earnings was to be expected.
Wells Fargo was similarly weak – $0.01 EPS vs $0.33 expected down to the build-up of a huge capital buffer against expected credit losses. The bank raised its reserves by $3.1bn and took a $950 impairment charge that produced a headwind of $0.73 on EPS.
Gold pushed up to set fresh 7-year highs with spot up at $1727. The move higher comes investors hedge their bets against a sharp decline corporate earnings and a deluge of central bank printing. US retail sales tomorrow and China’s GDP print on Friday are likely to be the chief macro events to focus on. Whilst the gold safety net is all about the decline in real yields, the idea that central bank printing will lead to inflation seems a step too far given the profoundly deflationary shock from Covid-19. Nevertheless, despite inflation and inflation expectations tumbling the impact of Fed and other central bank easing could see real yields drop further into negative territory.
Crude oil futures (Front month WTI) were weaker still with $22 cracking. The massive contango still leaves the Jun contract at above $29. The spread means Spot Oil on the platform is trading with a huge premium to the normal futures contract. A retrace to $20 looks possible for the futures and the real question is how the Jun and further out contracts can hold up where they are. Whilst OPEC has cut output and US production is coming off sharply, the massive build in inventories will surely take time to unwind and we do not see a sudden rebound in demand as economies take time to come out of lockdown. Even when restrictions are lifted, it will take time for people to drive and fly as much as they did. And as far as the OPEC deal goes, Oman’s March output was up 13% in March vs February.
In FX, the pound was unmoved by the OBR saying that UK GDP could decline by 35% in the second quarter. The coronavirus will cause a deep recession and a £220bn black hole in the public purse, according to the watchdog. This is a known – what matters is how soon the exit from lockdown and how quickly the recovery. The latter depends to a huge degree on how effective the fiscal support has been – how well has money and relief got to companies and individuals. The hit to sentiment long term is going to be much harder to get over.
GBPUSD held gains north of 1.2530. As per this morning, the pair is looking to hold the rally above the 61.8 retracement at 1.25150. March swing highs around 1.2650 offer near-term resistance to the bulls, as well as the 200-day moving average at 1.2657.