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Loan loss reversals portend an improving US economic outl

19012021

Bank earnings announcements last week from JPMorgan Chase, CitiGroup and Wells Fargo, three of US’s largest banks, marked the start of the quarterly earnings season. The key takeaway from the banks’ earnings results was the reversal of more than a total of $5 billion in loan loss reserves, which further supports the view of brighter economic days ahead.

The three banking giants managed to lock in positive earnings surprises for the quarter, despite that forward earnings estimates have moved higher over the past weeks. Factset reports that in aggregate, the US financial sector has recorded the largest upward revision in earnings estimates when compared to the other sectors. Fourth quarter earnings estimate increased across 85% of US financials, with Citigroup, JPMorgan Chase and Wells Fargo among the top five financial companies that recorded the highest increase in earnings expectations since the end of September.

The upward earnings revision during the fourth quarter was in fact mirrored in the relative outperformance of US financials, particularly the banking industry, relative to the general broad market index. US banks, up by 33% during the fourth quarter, notched the second highest gains after the energy sector and managed to outperform the US equity market by more than 20%. Given the strong banking rally leading to the earnings season, share price movements on the day of earnings results were in fact negative, with most of the positive announcements already priced in.

Out of the three banking results, JP Morgan Chase recorded the strongest quarterly results, beating earnings expectations by more than 44%. This was largely attributed to strong investment banking performance and the release of $2.9 billion of credit reserves. Chairman and CEO Dimon, cited positive vaccine and stimulus developments as the key contribution to the reserve reversal, notwithstanding the near-term economic uncertainty.

Similarly, Citigroup reversed $1.5 billion in allowances for credit loss reserves due to improvement in the global GDP outlook, fewer downgrades and lower net credit losses compared to those expected. The bank’s fourth quarter earnings recorded lower net income due to lower revenues and also higher expenses, with the bank’s efficiency ratio up to 64.9% compared to 56.9% in the previous year. Meanwhile, Wells Fargo’s quarterly earnings noted a $757 million in reserve release, due to announced sale of student loan portfolio and lower net charge offs.

As expected, net interest income was down across the board, reflecting the impact of a lower interest rate environment and balance sheet mix. JP Morgan Chase recorded an average loan increase of 1% compared to a surge of 35% across deposits. Wells Fargo reported the largest net interest income decline, of 17% compared to the fourth quarter of the previous year, due to various factors including lower interest rates, loan balances and investment securities balances.

This quarter’s earnings announcements also highlighted the bank’s intentions to restart their share buyback programs after the Federal Reserve gave the industry the green light to restart share buybacks in the first quarter. The amount of repurchases is conditional on recent earnings results and therefore, the better than expected results bodes well for share buyback expectations.

Disclaimer:

This article was written by Rachel Meilak, CFA, Equity Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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