Last week J.P. Morgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. reported results which were largely in line with what Wall Street had expected. Given these banks dominate Wall Street (with a few of their friends) that was to be expected. But did the reported results justify the strong rallies in their share prices leading up to their results?
Basically each of the banks reported strong trading revenue and sighted the increased asset price volatility that flowed from the US election. J.P. Morgan’s trading revenue climbed 24%, and Bank of America’s rose 11%. Wells Fargo’s relatively small presence in trading has sometimes been an advantage in recent years but was a handicap in the December quarter.
Looking forward, the recent upward move in interest rates is expected by their executives to produce gains in banks’ income. The market has grabbed onto this hope but at this point the interest rate moves may be tediously slow and confronted by a rising USD which would not be good for the US economy.
Affecting the quality of the results, but bolstering the actual numbers was the release by each bank of loan provisions, or reserves, that they had set aside for expected loan losses. As the US economy has rolled forward credit quality has improved, and so the banks have been able to write back provisions and push up reported profits.
We regard trading revenue and reserve releases as lower quality earnings than pure bank lending revenue. Importantly in the recent quarter, consumer banking was not buoyant. Revenue was down at J.P. Morgan and Wells Fargo versus the prior year, and flat at Bank of America. Mortgage-banking revenue was also challenged due to the rise in interest rates and looks set to continue falling this year.
Expense management remains an intense focus and improvements were noted here. At Bank of America, CEO Brian Moynihan has made expense savings a key part of his business strategy, and the company cut annual expenses nearly 5%, to $54.95 billion. Moynihan has “promised” (trust me I am a banker) to reduce annual expenses to about $53 billion by 2018.
The following tables are presented to show that underlying US bank earnings, based on traditional banking, have really not improved. The tables below show that over the last five years:
- Net interest margins remain under pressure. Wells Fargo (WFC) net interest margins have declined whilst Bank of America (BAC) have held at low levels;
- Revenue growth has been anaemic for both banks. Earnings growth will be driven by cost reductions and reserve write backs;
- Dividend yields remain low with WFC sitting at 3% and BAC at just over 1%;
- Return on equity for WFC has fallen to about 10% after their customer scandal. The recovery in BAC earnings has taken ROE back to a relatively poor 7%; and
- Despite this, both banks trade at relatively high PERs of 13 times projected for both WFC and BAC. These PERs are comparable to Australian banks that have higher ROEs and higher dividends which are franked.
In recent weeks, at Clime managed funds, we have sold down our positions in US bank stocks because we perceive that the rerating of their share prices overstates their true value.
Figure 1. Wells Fargo Financial Statements
Source. StocksInValue / Clime
Figure 2. Bank of America Financial Statements
Source. StocksInValue / Clime