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Daily Intelligence Briefing

Wednesday, January 19, 2022

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Banking Industry Breakout Stumbles on Weaker Earnings, Flatter Yield Curve

Summary: US financial sector earnings are in full-swing, but several major banks have posted disappointing results for Q4 2021. Despite strong full-year results for most, profit growth slowed or even declined in the final leg of the year amid rising operations costs, largely stemming from compensation.

Loan growth has finally shown signs of recovering, but that rebound appears to be fragmented and is yet to surpass pre-pandemic levels. Rising long-term yields have powered an explosive start to the year for banks’ share prices, but a swift gain in short-term yields has begun to flatten the yield curve.

Related ETF & Stocks: SPDR S&P Bank ETF (KBE), JPMorgan Chase & Co. (JPM), The Goldman Sachs Group, Inc. (GS), Citigroup Inc. (C), Jefferies Financial Group Inc. (JEF)

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After nearly a month of surging share prices, major financial institutions have faced a wave of selling this week in light of lackluster earnings figures. Per the Wall Street Journal, banks in the S&P 500 were expected to report total profits of about $31.2 billion for the fourth quarter, marking a 2.4% decline from a year earlier. Several of these banks have missed expectations for earnings or revenue.

Jefferies’s earnings, reported last week, were a foreboding signal for the financial sector. Despite record results in its investment banking division, Barron’s notes the bank cited “challenging market conditions” for fixed-income trading’s weaker results. Profits were just $1.20 per share against expectations of $1.34. Revenue fell 3% to $1.8 billion, short of estimates for $1.9 billion.

Though JPMorgan Chase capped 2021 by reporting record profits for the year and Citigroup’s annual profit more than doubled, both banks still disappointed when compared to Q4 expectations.

Citigroup reported Q4 earnings of $1.46 per share, worth net income of $3.17 billion. That was down from $4.3 billion in the year ago period, equivalent to $1.92 a share. Revenue increased to $17 billion from $16.8 billion. Each of those beat earnings but the overall decline in quarterly profit was enough to send shares lower last Friday. Citigroup stock is now about 4% lower than its close prior to reporting.

Despite a 37% jump in fees collected by its investment bankers, JPMorgan’s overall profit in the three months ending in December fell 14%, to $10.4 billion, from the same quarter in 2020. That helped earnings per share (EPS) bounce to $3.33, versus an estimate of $3.01 from Refinitiv, but that marked their smallest quarterly earnings beat in nearly two years. Additionally, management reiterated that return on equity will likely be below target in 2022, with comments indicating this may continue into 2023.

One of the most critical disclosures in JPMorgan’s earnings was that it took a $1.8 billion net benefit from releasing reserves for loan losses that never materialized. CNBC notes that, without that 47 cent per share boost, EPS would have been just $2.86 per share.

As MRP noted prior to the Q3 2021’s round of bank earnings last October, banks have boosted profits on releasing reserves since they built up a $50 billion pile of cash during 2020. Now that those releases have created a high bar for YoY comparisons, lending will need to pick up precipitously to see banks continue expanding their profits. That will increasingly depend on whether banks finally experience a strong rebound in lending in the quarters ahead.

Though the Wall Street Journal notes that loan growth is starting to tick higher after a lull through much of the pandemic, they’re only now regaining ground on early 2020 levels. Total loans at US banks reached $10.76 trillion at the end of December, up 2.8% from the end of September.

Goldman Sachs managed to beat their revenue estimates, drawing $12.64 billion versus an estimate of $12.08 billion, but fell short on earnings. Goldman reported EPS of $10.81 against Refinitiv’s expectation of $11.76. Per CNBC, Goldman noted that operating expenses jumped 23% to $7.27 billion in the quarter, exceeding the $6.77 billion estimate of analysts surveyed by FactSet.

For Citigroup, JPMorgan, and Goldman Sachs, each saw rising operations costs driven by surging compensation throughout the financial sector, a symptom of rising wage pressures across the broader economy. The 33% rise in pay at Goldman throughout 2021 was equivalent to a 33% gain in revenue.

Despite bank earnings getting off to a rough start, it’s not too late for Bank of America and Morgan Stanley to turn the tide when they report their quarterly earnings this morning. However, it seems investors have already been pricing in expectations for similar weakness. Shares of each of those banks closed nearly 3.5% and 5.0% lower yesterday, respectively.

Though a building rebound in lending and the potential for a steepening yield curve, spurred on by tighter policy at the Federal Reserve, have been among the top catalysts driving bank stocks as of late, those narratives have been weakened by this week’s spate of earnings and the Fed’s increasingly aggressive language toward rate hikes.

Some contend that a fast pace of monetary policy readjustment to curb inflation could end up being overdone, leading to a flattening of the US Treasuries yield curve. A steeper yield curve generates more profitable conditions for banks, which prefer to borrow money at lower short-term interest rates and lend at higher long-term rates. Per Reuters, the curve between 2 and 10-year notes flattened to 81 basis points on Tuesday, the smallest yield gap since January 3.

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