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Big US bank earnings show momentum in loan growth

Another round of earnings beats by the biggest U.S. banks has kept alive the bull thesis that the industry is on the cusp of better days as interest rates rise and loan growth picks up.

Third-quarter earnings at the largest banks were buoyed by continued strength in credit performance and robust capital markets revenues, which did not fundamentally alter analysts' narrative on the sector as they expect moderation in coming quarters. But many analysts were focused on loan growth, and JPMorgan Chase & Co. and Bank of America Corp. both gave upbeat outlooks. BofA guided to "robust improvement" in net interest income in 2022.

"The level of loans has now turned" at BofA, said David Fanger, a senior vice president at Moody's, in an interview. "It's certainly not rising as steeply as it fell, but it is rising."

Jefferies analyst Ken Usdin wrote in an Oct. 14 note that he expects 6% growth in net interest income at BofA for 2022.

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The outlooks were more subdued at Citigroup Inc., which kept to its forecast that revenues will decrease by a mid-single-digit percentage in 2021, and Wells Fargo & Co., which said it is still headed toward the lower end of its net interest income guidance for this year.

While average loans ticked down sequentially at Wells Fargo, end-of-period loans increased 1.2% to $862.83 billion. The end-of-period loan growth was "the key to the quarter," wrote David Konrad, an analyst at Keefe Bruyette & Woods, in an Oct. 14 note, adding that it points to stronger earnings power ahead.

Rising interest rates have also improved the outlook for income from securities holdings, although some banks said they will continue to be cautious.

Wells Fargo CFO Michael Santomassimo emphasized his bank's focus on the potential for rates to rise further because of factors such as inflation. "We're still being pretty patient" in terms of adding to the bank's portfolio, he said on an earnings call, but "when opportunities present themselves, we'll take advantage of them." JPMorgan Chase CFO Jeremy Barnum similarly said his bank is "happy to remain patient," although the recent rise in rates has brought returns closer to the bank's expectations.

At BofA, whose allocation to securities has shot up since the end of 2019, CFO Paul Donofrio said on an earnings call that the bank would continue to balance liquidity, capital and earnings as deposits pour in. He added that BofA remains highly asset sensitive.

"Each firm has its own views," said Fanger. "Either is a bet. Nobody is right and nobody is wrong until after the fact."

In terms of credit performance, large reserve releases once again led to negative provision expenses that easily outpaced analyst forecasts. Banks said additional reserve releases were possible if economic uncertainties continued to dissipate, though the scale of the negative provisions generally moderated for the second quarter in a row as the group draws down cushions built up at the beginning of the pandemic.

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Wells Fargo was the exception, with a negative provision that increased for the third consecutive quarter, reaching $1.40 billion in the third quarter. Nevertheless, Wells Fargo continues to appear relatively cautious in winding down its excess reserves, which remain more than 50% larger than when it initially adopted current expected credit loss accounting at the beginning of 2020. By contrast, recent reserve releases at JPMorgan Chase and BofA have left their allowances at about 15% to 20% higher than their CECL Day 1 levels.

Santomassimo said economic conditions when reserve levels were established at the beginning of 2020 were "utopian" and that Wells Fargo's current allowance reflects "a number of different scenarios." However, "it hopefully will prove out to be very conservative relative to what plays out over the coming quarters," he said, acknowledging that "so far, we've all, I think, in the industry have been wrong about when credit or how credit will normalize."

In fact, quarterly net charge-offs continued to decline at each of the Big Four, and analysts did not view the reserve releases as merely pulling forward the reversal of pandemic stockpiles. Expectations for lower credit costs in 2022 factored into increases in EPS forecasts for Citi by Jefferies and Credit Suisse, for example.

Analysts and investors also took in stride updates from Citi and Wells Fargo on their efforts to reshape themselves and address regulatory issues.

Citi said it had submitted a plan to overhaul its risk controls to regulators, and that it is "deep" into the second round of bids for operations it is seeking to divest around the world after agreeing to sell its consumer operations in Australia.

Citi has "a long list, but I think selling Australia is the first piece of the strategy," said Peter Nerby, another senior vice president at Moody's. "Citigroup is much simpler, safer and sounder than it was, but it's still very complex, and they want to make it less complex."

Wells Fargo warned that additional setbacks are likely as it works to satisfy multiple consent orders, but the bank showed progress on a multiyear efficiency effort with a 12.6% year-over-year drop in noninterest expenses.

"They are doing what they say they're doing," said Steven Check, president and chief investment officer of Check Capital Management, which has a long position in Wells Fargo's shares.

"We just see more upside, certainly at these valuations in Wells Fargo," Check said. "Wells Fargo's efficiency ratio is coming down, but it's still 10 points above where it historically has been and where the other big banks are. So that's pretty low-hanging fruit if you can get through all the crappy headlines."