Big U.S. banks reminded investors as the fourth-quarter earnings season rolls along that the economic environment remains incredibly profitable.
Brewing trade wars and a government shutdown barely made a showing in the earnings for large banks. Those political concerns appeared to drive a volatile 2018 fourth quarter that hammered bank stocks. Earnings reports this week from the largest banks showed little adverse impact, and investors piled back into bank equities, sending some stocks up as much as 10% in a few days.
"We clearly see a disconnect between what we see in our business on an anecdotal basis and what the markets are saying," Citigroup Inc. CEO Michael Corbat said during the bank's Jan. 14 earnings call, before the week's rally. He reiterated that economic fundamentals appear strong, and recessionary risks are largely limited to sentiment.
Citigroup was the first of the Big Four banks to report earnings. Some of the company's key metrics deteriorated in the 2018 fourth quarter, with its efficiency ratio increasing and its net interest margin dropping from the previous quarter. Compared with the year-ago period, the bank's efficiency ratio was still higher and its net interest margin was up just 2 basis points.
Still, the company's profits were strong, which some analysts attributed to benefits from tax reform. Keefe Bruyette & Woods analyst Brian Kleinhanzl titled his Jan. 14 note, "The tax man still delivering presents and estimates move higher." Kleinhanzl did not expect the bank to deliver on its guidance for returns, predicting the bank will "fall short of management's targets, and that will weigh on shares longer term." At the same time, Kleinhanzl said the bank's stock could reach tangible book value, which was $63.79 as of Jan. 16. The stock closed that day at $62.19.
Vining Sparks analyst Marty Mosby was more constructive on the bank, suggesting the fourth-quarter performance might be sustainable. "It appears that Citigroup is finally able to sustain a return on equity that exceeds its cost of equity and should be able to eventually sustain a valuation in excess of its tangible book value," Mosby wrote in a Jan. 14 note.
JPMorgan Chase & Co. and Wells Fargo & Co. were next to report, releasing results Jan. 15.
On core metrics, Wells Fargo reported modest quarter-over-quarter improvements in both efficiency ratio and net interest margin. Investors appeared more interested, at least initially, in a regulatory update. Management said its asset cap will likely remain through year-end. The bank's stock sold off to start the day of its earnings report, but the sell-off was short-lived, as the bank's closing price Jan. 16 was its highest level in a month.
Some analysts described Wells Fargo's performance as disappointing, missing consensus estimates on fundamental metrics such as revenue. Raymond James analyst David Long wrote that the bank would have missed on earnings if not for benefits from tax reform. Citing the asset cap extension and a lack of a positive catalyst, Long wrote that the bank's share should underperform peers.
On the other hand, Baird analyst David George sees upside for the bank's stock. "We expect many of the headwinds were temporary or due to one-time items, and we are encouraged by [Wells Fargo's] return to loan growth," George wrote in a Jan. 15 note.
While JPMorgan's net interest margin moved higher, so too did its efficiency ratio. Management made no apologies for the higher expense ratio, attributing it to the bank's effort to invest in the strength of the franchise.
"While we could obviously make changes, we would not look to do that," CFO Marianne Lake said. "And so marketing expense, for example, is one area where you would say that is pretty sizable and has immediate flexibility. Nevertheless, when we invest in marketing, we're driving new accounts and engaging customers that drive long-term growth."
JPMorgan also had a few unexpected credit quality issues, increasing provisions because of a select few commercial and industrial loans. Analysts were forgiving, agreeing with management that the credit issues appeared to be idiosyncratic. Jefferies analyst Ken Usdin wrote in a Jan. 16 note that he lowered cost growth estimates in future quarters despite the bank's fourth-quarter miss, attributing it to efficiency improvement.
Bank of America Corp. was the last large bank to report, releasing results Jan. 16 that easily outpaced consensus estimates on the back of broad-based growth. The company's efficiency ratio was flat quarter over quarter, now the lowest among the big banks after being the highest in 2016. Its net interest margin popped 7 basis points in a single quarter and was 11 basis points higher than the year-ago quarter.
The bank reported robust net income figures across nearly all of its business segments. Analysts highlighted the bank's higher noninterest income figures and continued strength in deposit growth. Investors were enthused by the results, sending the stock up more than 7% in a single day.
Management expressed confidence that the bank's profits would continue despite macroeconomic concerns such as the continuing government shutdown or weakening global demand.
"The predictions of potential slowdown in the economy don't enervate us, they invigorate us," said Chairman and CEO Brian Moynihan. "We've built this company to operate in that setting."
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