Three of the biggest U.S. banks—JPMorgan Chase, Goldman Sachs, and Wells Fargo—report Q2 results this week. Comparisons to a tough year-ago quarter could mean big earnings gains, but slow trading in fixed income and weak rates might drag.
After riding swift tailwinds through Q1, the biggest U.S. banks could face tougher times as Q2 earnings loom.
That doesn’t mean Q2 year-over-year earnings growth for the Financial sector won’t be immense. Remember, at this time a year ago, the industry was struggling through the worst of the Covid shutdowns. With comparisons on the easy side, analysts project an amazing 117% earnings per share growth for Financials in Q2, according to research firm FactSet. That’s the third-highest projection FactSet has on a sector basis.
This comes after the Financial sector posted 34.5% earnings growth in Q1, a banner quarter for the big banks thanks in part to blistering performance in their trading and investment banking businesses.
The concern as Q2 earnings season approaches is that earnings might be peaking as trading activity slows and interest rates remain stubbornly low. A decline in “special purpose acquisition companies” (SPACs) activity during Q2 might also have hurt the sector.
In one sign of changing times, JP Morgan Chase (JPM) CEO Jamie Dimon said last month the bank now expects $52.5 billion in net interest income in 2021, down from the $55 billion it anticipated in February, as the firm stockpiled cash and on lower credit card balances.
The big banks don’t typically get too granular on guidance, so the important thing for investors is to listen closely to what their executives say on their earnings calls about the economic environment and where they see it heading in coming months.
JPM, Goldman Sachs (GS), and Wells Fargo (WFC) kick off earnings season this week ahead of Citigroup (C), Bank of America (BAC), and Morgan Stanley (MS). As they get ready to report, they face a very different environment than just three months ago.
At that point, the rate picture looked far more friendly for banks. The key 10-year yield had soared from under 1% at the start of the year to above 1.75% by late March, giving banks a nice boost. Remember, one way banks profit is by borrowing money at lower rates and lending it out at higher rates. A yield curve that had been gaining steam since the worst days of the pandemic gave banks a boost, but now it’s narrowed.
As yields basically marched in place over the course of Q2 and the Fed kept up its mantra that recent inflation is “transitory,” Wall Street trading activity in fixed income—another big profit source for banks—died down quite a bit. Yields entered range-bound territory and pretty much stayed there from early May right on through to the end of June. By July, the 10-year was back under 1.4%. That doesn’t exactly indicate booming times for banks’ trading businesses, most of which saw a major benefit from Covid-associated volatility until recently.
Even the stock market mostly went into a holding pattern during Q2, with major indices grinding slowly higher to new records but very few days of 1% gains or losses. In fact, trading was about as dull and uninspired as we’ve seen since the dog days of 2018, and the Cboe Volatility Index (VIX) fell to post-pandemic lows by June.
As always, investors should consider focusing on the separate fortunes of equities and fixed income trading, where there’s often bifurcation.
In one positive development, the sizzling housing market and continued strength in U.S. manufacturing mean more households and businesses might have been out there borrowing last quarter, a potential boost for banks. This could go especially for big banks with major consumer-facing businesses like credit cards and home mortgages.
Most of the major banks put large amounts of capital into “loan loss provisions” over the last year as a shield in case of default from clients, but began pulling those back pretty significantly as 2021 progressed. These protective measures weighed on earnings in 2020, but may be less of a factor in coming months. One interesting thing to look for as banks report is what they say about rolling back more of this caution, because it could potentially flow back into the bottom line.
In addition, one of the measures banks took to protect themselves in the down years, including cost cutting and higher fees, aren’t going away and could continue to provide traction. Also, the big banks last month passed the Fed’s “stress test” with flying colors, allowing many of them to raise dividends and potentially buy back shares.
Despite those worries, Financials are the second best-performing sector year-to-date, up more than 25% through early July. Only Energy (another downtrodden sector until recently) gained more ground since Jan. 1.
We’ll examine MS, BAC, and C in a subsequent preview, but for now let’s focus on the first big banks to report, led by JPM and GS on Tuesday followed by WFC on Wednesday.
FIGURE 1: LOSING GROUND. After tracking well ahead of the S&P 500 Index (SPX—purple line) for much of 2021, JP Morgan (JPM—candlestick), the biggest U.S. Financial stock by market capitalization, has had a tough month and is now well under the pace being set recently by the SPX. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
When JPMorgan Chase releases results, it is expected to report adjusted EPS of $3.17, up from $1.38 the prior-year quarter, on revenue of $29.95 billion, according to third-party consensus analyst estimates. Revenue is expected to fall 1.1% year-over-year.
The options market has priced in a 2.1% stock move in either direction around the upcoming earnings release, according to the Market Maker Move indicator on the thinkorswim® platform. Implied volatility was at the 11th percentile as of Monday morning. Looking at the July 16 options expiration, puts have been active at the 150 strike but there’s been greater activity to the upside, particularly at the 160 strike.
Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.
JPM shares remained solid in Q2 despite recent worries about falling rates and soft fixed income trading. The bank is considered an industry leader thanks to what it calls its “fortress” balance sheet, and as the U.S. bank with the most assets. Also, CEO Dimon tends to be influential, with the market sometimes moving on his words in the company’s earnings calls.
Last time out, JPM demolished analysts’ earnings Q1 projections, with revenue coming in well above Wall Street’s estimates thanks in part to strength in the company’s trading operations. JPM also got a $5.2 billion benefit from releasing money it had previously set aside for loan losses that didn’t develop.
Neither of those tailwinds can necessarily be counted on this time around, considering the condition of fixed income trading in Q2 and the fact that JPM and many big banks have already dialed back those Covid-related loan reserves. The loan reserve drawdown has been an accelerant for bank earnings the last two quarters, but the question is how many times can you milk the same cow?
On the earnings call, Dimon is likely to face questions that go well beyond JPM’s own books and into the state of the economy. It will be interesting to get his take on the Fed’s most recent minutes released last week, especially since he said in June he expressed doubts about the Fed’s repeated claim of inflation being “transitory.”
“We have a lot of cash and capability and we’re going to be very patient, because I think you have a very good chance inflation will be more than transitory,” Dimon said last month, according to media reports.
The question might be, what does the company believe is worth investing in and what will the rate picture have to be for it to use some of the $500 billion in cash Dimon says the bank is “stockpiling.”
Also, remember that if some of JPM’s potential earnings come from releasing loan loss reserve money, that’s not likely to be a recurring source of profit. In fact, last time out Dimon said he didn’t consider that part of earnings to be a true reflection of the bank’s bottom line. Investors should probably look at it the same way, both for JPM and other big banks.
The credit card issue Dimon referred to could be a challenge for JPM and other banks. Some industry followers say they’ve seen higher rates of people paying off their credit card balances, which of course could mean lower interest income for the processors. Also, government checks appeared to swell many peoples’ savings accounts, which may mean less need to use credit to buy smaller-ticket items, research firm Briefing.com observed.
Goldman Sachs is expected to report adjusted EPS of $9.95 vs. $0.53 in the prior-year quarter, on revenue of $12.17 billion, according to third-party consensus analyst estimates. Revenue is expected to rise 24.9% year-over-year.
Options traders have priced in a 3% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator. Implied volatility is at the 11th percentile as of Monday morning.
Looking at the July 16 expiration, options volume has been light overall, with some activity in the 350-strike puts and 400-strike calls.
Goldman Sachs is the big bank that gets the largest chunk of its revenue from Wall Street trading and activity. That means the softer trading environment of Q2 might have dragged its business. Remember that in Q1, GS trounced analysts’ expectations. The trading business hummed along and investment banking—another huge area for GS—delivered strong returns.
In Q2, slower trading activity and a decline in SPAC activity may weigh, even though year-over-year results are expected to be strong.
Way back in January during the GS Q4 earnings call, GS CEO David Solomon warned that the boom in equity issuance by SPACs isn’t sustainable.
“There will be something that will in some way, shape or form bring the activity levels down over a period of time,” Solomon said. “Like many innovations, there is a point in time as they start where they have a tendency maybe to go a little bit too far and they need to be pulled back or rebalanced in some way.”
Recent regulatory warnings have raised questions around the accounting and revenue projections for many SPACs. Additionally, SPACs’ rapid growth spurred exchanges to begin exploring ways to cut red tape and streamline the initial public offering (IPO) process.
“There’s no question that enthusiasm for SPACs has waned since the peak of exuberance in mid-February,” SPAC Research stated in a report earlier in Q2. “The market has softened, and investors are no longer scooping up anything they can find just because it has the word ‘SPAC’ attached.”
The regulatory concerns helped send SPAC stocks down sharply. New SPAC issuance dwindled to 20 deals from April through mid-May, compared to nearly 300 during the Q1, according to SPACInsider. None of this is particularly great news for GS or other big banks hoping to capitalize on the trend, but it could mean they get more aggressive pursuing the IPO business.
One thing GS can perhaps shed light on its earnings call is the future of the mergers and acquisitions (M&A) and initial public offerings (IPO) markets. Some of the “SPAC mania” has died down but you’re starting to see a strong pickup in IPO activity and hearing reports of a likelihood of M&A activity which could be a nice second-half benefit, Briefing.com said.
Usually a market featuring plenty of IPO and M&A activity means healthy times for big investment banks, and GS has a huge exposure here. Tech has been a leader in IPOs so far this year, and that could continue if you look at some of the companies planning to go public later in 2021. Biotech also has been jumping on the IPO bandwagon. There was a flurry of activity in biotech IPOs recently. Of the 16 companies that listed their shares one week in mid-June, 10 were in the biotech space or provide tools to biotechs, Barron’s noted.
In Q1, GS reported strength in its Investment Banking and Global Markets businesses, with underwriting providing a big chunk of the Investment Banking growth. Financial advising also grew nicely. Those are areas to watch for potential continued strength when GS reports Q2 results.
Also look for the company to potentially use the earnings call to provide updates on its plans to grow wealth management and consumer banking.
Wells Fargo is expected to report adjusted earnings of $0.96, vs. a $0.66 loss in the prior-year quarter, on revenue of $17.78 billion, according to third-party consensus analyst estimates. Revenue is expected to be down 0.3% year-over-year.
Options traders have priced in a 3.8% stock move in either direction around the coming earnings release, according to the Market Maker Move indicator. Implied volatility was at the 11th percentile as of Monday morning.
Looking at the July 16 expiration, volume has been heaviest at the 40- and 42.5-strike puts, with some upside concentration at the 45- and 47.5-strike calls.
One big bank on Wall Street that’s had some issues lately is Wells Fargo. The “fake account scandal” from a few years ago continues to be a drag for the company, but its shares spiked when WFC reported stronger than expected Q1 earnings.
To be fair, some of the strength came from WFC releasing reserves it had set aside for possible protection against Covid-related defaults. That’s not necessarily in the realm of “organic” growth. Still, WFC raised some optimism last time out when it said it hoped for a recovery in the commercial side of its business as the economy improved.
The company is the biggest mortgage lender in the U.S., and the sizzling housing market continued for much of Q2, though it’s leveled off a bit over the last month.
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