Wednesday, January 30, 2019

Big Banks' Big Year

Despite volatile stock prices, big banks have begun to report blockbuster 2018 earnings in early 2019.
Bank stocks, especially those of the big, familiar "too big to fail" banks, fluctuate in value too often.  They did for much of the last quarter. Whatever happens in economies and financial markets around the globe appear to have immediate impact on bank stocks. If the economy in Taiwan coughs, then it might have impact on Goldman Sachs' market value.  If oil prices capsize, then investors presume banks will suffer losses from oil-and-gas loans, and the stock shares plummet.

Hints of a global economic recession, uncertainty in China-U.S. trade talks, the agonizing shutdown in Washington, and fear of just about everything have caused markets to shake vigorously the past few months. Take the stock of Citi (now at about $62/share). A year ago, the price had approached $80. In December, it dipped into the low 50's. Bank of America share prices (at $29/share) had been comfortably above 30, but slid below 24 in December.

No doubt big banks touch market and economic activity everywhere. They influence it, but they are influenced by it.  A change in interest rates, shifts in yield curves, or deteriorating perspectives about technology companies sometimes lead to risks and losses at financial institutions. Quickly.

Yet despite worries among investors and doomsday projections from economists who enjoy the attention they get after they predict the end of the financial world, as big banks have begun to report  2018 performance, many of them have done quite well.  Bank of America, JPMorgan Chase, and Citigroup, for example, reported annual net earnings of over $18 billion each, levels of performance they have never achieved and with returns on capital they haven't reached in a financial generation.

Granted, they are benefitting from a generous tax code, new tax legislation enacted a year ago.  JPMorgan, for example, paid 31% of pre-tax income in taxes in 2013; in 2018, it paid 20%. In 2018, it paid about $4 billion less in taxes than what it would have paid in 2013 (at a 31% effective rate).  That alone explains a 1% increase in its after-tax ROE in 2018.

But JPMorgan and other big banks have benefitted from steady increases in operating earnings--as they continue to spread their wings in many geographic and product directions (while quietly whispering about how financial regulation still keeps their hands tied). They leaped aboard the momentum of the last decade's improved economy; they have responded to threats of competition from financial technology upstarts. They have survived the ongoing threats (so far, as they cross their fingers) of cybersecurity.

So from year to year, they inch upward. They have grown their consumer and corporate loan books, have been prudential about loan-loss reserves, have retained and even increased deposits, have ensured they have more-than-excess amounts of capital and have stuck to their guns in finding ways to make money from trading (despite the handcuffs of Volcker regulation).

They get frustrated they can't grow their favorite businesses (fees from asset management and fees from investment banking) by double-digit percentages. But they embrace the minimal impact these businesses have on their balance sheets and capital requirements.

The big banks addressed bad loans. Bad loans and bad assets (especially in the mortgage categories) suffocated banks--legally and in performance.  It took almost a decade.  By 2018, loan portfolios on the balance sheet look more pristine. Non-performing loans and assets (impaired loans) have steadily declined (below 2% of total loans in most cases).  Loan-loss provisions (in expectation of future losses) have declined, suggesting that new loans booked are of better quality or have better protection (collateral, guarantees).

Such "success" (including not just operating results, but vastly restructured and improved balance sheets) have come with an expected consequence.  The same banks have comfortably passed Federal Reserve stress tests in the past year; hence, bank regulators have permitted them to reward shareholders with higher dividends and share buybacks.  The same banks blamed for contributing to the financial crisis have reached a success point where regulators have approved decreases in capital on the balance sheet and are tolerating a wee bit more leverage (while still, of course, ensuring they meet all the Basel and Dodd-Frank capital requirements handily).


By historical standards, Citi had a blockbuster year, reporting $18 billion in earnings and stepping up to a 10% ROE plateau after years in the single digits.  The bank spent much of a decade cleaning up its balance sheet ("good bank" separated from "bad bank"), reducing credit risks and ensuring it had sufficient liquidity to reach tough Basel liquidity standards.

It felt strapped in boosting the loan book while its peers did so eagerly. In 2018, it finally increased the corporate loan book and increased overall loan net-interest earned after years of outright flatness.

Trading securities, currencies and commodities around the globe is still important at Citi. Performance in 2018 ($9 billion trading income) was flat. The bank might accept that--given the volatile markets in the last quarter. (Banks look for customer-flow volume to achieve trading gains. Often volatile markets spark customers to buy and sell assets, which can lead to trading gains at dealer banks.)

What might be overlooked at Citi is how earnings improvements have resulted, too, from cost management. Profit margins and operating efficiencies have gotten better and rank admirably among peers, even if it is hard to imagine where else the bank can cut costs to improve margins in the years to come.

Nonetheless, watch out.  The bank has felt comfortable reducing capital and increasing leverage (okay, to keep shareholders interested and happy for now).


"Too big to fail?" JPMorgan Chase continues to get bigger and bigger.  Its balance sheet now tops $2.6 trillion in assets. On the same balance sheet, its loan portfolio will likely eclipse the $1 trillion mark later this year. Loans are booked in all possible borrower categories--credit cards, mortgages, small-business loans, bridge loans, and large corporate financings. Deposits continue to pour in from domestic and foreign branches (mostly deposits that pay interest) and could reach $1.5 trillion this year. Cheap deposits around the world support the loan portfolio.

But this is a trading behemoth, as well.  Trading-related revenues topped $12 billion in 2018 (Compare with Goldman's $8-9 billion annually).  Trading assets amount to over $400 billion (or about 15% of the balance sheet.) (That includes its big derivatives-dealing role, which, some argue, might be understated on the bank's balance sheet.)

There are substantial (and growing) trading risks at JPMorgan (as measured by the industry's "value at risk" metric). JPMorgan's "VaR" metric ($51 million maximum one-day loss) suggests a marked increase in trading risks the past year--likely due as much to exceptional volatility in 2018 on the same level of trading exposures.

The bank reported handsome upturns in most business lines--even in asset management (11% increase) and investment banking.  The increase in that loan book (with some help with increases in interest rates that contribute to increases in interest income) contributed to the $5 billion increase in net-interest earned.

Increases at JPMorgan at just about every important business area in all parts of the globe led to $33 billion in net income. Yes, the $4 billion tax gift helps, too.  The 2018 performance resulted in the 13% ROE the bank reached for the first time since the combined big bank consisted of separate existences of old Chase, old Chemical, old JPMorgan and even old Manufacturers Hanover.

Like Citi, it has benefitted from cost management and efficiencies.  Operating costs have increased across the board, but as JPMorgan's leaders often specify: "It's not about cost reduction; it's about cost control" (arguing that some costs are necessary to grow and get big around the world).

On the heels of one of its best years ever, the bank has seen its stock bounce way up and then way down.  In September, share prices had touched $120; by December, they had sunk below $95 and have recently hovered about $102.


Bank of America raises the earnings flag to boast, "We, too." The bank's net income leap-frogged up to $28 billion, sufficient for a 11% ROE, a return that tops 10% for the first time in memory. It, too, was blessed by generous tax relief, paying about $5 billion less in taxes than it would have had to do so in 2016.

The bank replicates JPMorgan in many ways--in size, scope, business lines. They certainly compete head-on--in consumer, corporate and investment banking. Like JPMorgan, Bank of America has similar sizes in loan portfolios, deposits and total balance sheet.  Bank of America, a storied, big investment bank in its own way (thanks to the Merrill Lynch lineage), trails JPMorgan in trading assets, trading income, and investment-banking revenues.

Still, like JPMorgan, Bank of America has "contained" and "controlled" costs (steady improvement in operating-efficiency ratios) and has felt satisfied enough to do what its peers have done:  Reduce capital by giving some of it back to shareholders in the way of dividends and buybacks.

Leverage has increased and is as high as it has been since 2013. The bank will be the first to assert that 2013's balance sheet was still stockpiled with market and credit risks, bad loans, illiquid mortgage-related assets and who knows what else.

So in sum, they quietly toot their horns and pat their backs and thank legislators and regulators who have permitted than to boost dividends and buy back stock.

Now if only if stock prices can proceed at a more predictable, tolerable pace.

Tracy Williams

See also:

CFN:  Dodd-Frank Tossing and Turning, 2018
CFN:  A Spike in Bank Stocks? 2017
CFN:  What is CECL to Banks? 2017
CFN:  Wells Fargo's Woes, 2016

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