This has been an incredible quarter for "the big four" banks, as all have exceeded analyst expectations and profits. They have grown quite a bit since the beginning of the year and I am wondering just how far can they go? Let's take a look at how efficiency has increased revenue and earnings for the banks. This will give us a better handle on the potential growth of the four main banks as the economy improves.
One of the things that I like to observe with the banks is their efficiency ratios. If you are unfamiliar with this ratio, an efficiency ratio is simply a ratio that one comes up with by dividing a bank's expenses by its revenues. This enlightens investors as to how much money the bank has to spend in order to bring in revenue.
In recent years these ratios have been higher than normal because the banks have faced legal pressures, issues related to credit and of course regulatory pressures from the Feds. Historically speaking, efficiency ratios have hovered from 55% to 60% and it looks like banks are getting back down to that level.
Lower efficiency ratios are better because it shows the banks are more profitable. They are spending less money to bring in more money. This should be reflected in an increased earning power and we should see overall earnings getting better, therefore ROC should also begin to improve.
Looking at the chart above, you will notice that Bank of America (BAC) has had the greatest challenge in remaining profitable. Its fourth quarter was its worst performing quarter of the last six; since that time it has been able to rein in expenses and has come very close to being on equal ground with the other banks. BAC is not the favorite bank of consumers right now, but one must admire how they have been able to bring their efficiency ratio down so much, since the fourth quarter.
Citigroup (C), JPMorgan Chase (JPM) and Wells Fargo (WFC) are all very close in their ratios with Wells Fargo consistently being the most efficient of the four banks over the last six quarters. While JPMorgan Chase has been one of the more profitable banks as of late, it looks like Citigroup has had the greatest challenge in trying to become more efficient. Looking at the bank from the first quarter of 2012, it has barely been able to move that ratio lower. For the "Money Center Bank" industry, it is good to see these ratios coming closer together and dropping like they are.
Increased efficiency by the banks is a natural catalyst to improved earnings and returns that should continue to push their stock prices higher.
There will come a time when efficiency ratios will plateau; or the stocks to continue to increase in value revenue will have to take over. This should be a natural process as our economy continues to get better because it should translate into more money for consumers and increase revenue for the banks.
Even though Bank of America has done the best to lower its efficiency ratio, it has not translated into consumer deposits increasing. The bank has seen lower deposits while the other banks have either stayed consistent or increased their deposits. Over the last five quarters the other three banks have increased and JPMorgan Chase has consistently showed improvement and ranks on top as consumers' choice for deposits.
Along with increasing deposits, providing loans is another way to show revenue growth. As you can see from this graph, JPM has also given out the most loans of the four banks. I don't think it's worth mentioning because it seems fairly insignificant, but over the last five quarters its total dollar amount of loans has fallen. While BAC has dropped in deposits its bank loans have consistently risen except for the second quarter of this year. Citigroup and Bank of America have grown while Wells Fargo has consistently dropped over the last five quarters due to mortgage rates.
Recent Quarterly Reporting
Bank of America saw net income rise by 63% year-over-year driven by net interest income, investment and brokerage income, investment banking fees, sales and trading revenue, equity investment income and credit quality, as well as, expense reductions.
At the beginning of the year the company was focused on three things in order to increase profitability:
- Revenue Stability
- Strengthening the Balance Sheet
- Managing Costs
This quarter revenue increased by 3% and even though higher interest rates has put a damper on its bond portfolio; it has still been able to build its capital ratios. The company also continues to cut the expenses that are tied to servicing delinquent loans faster than it anticipated it could.
Citigroup continues to successfully reduce its risk in "Citi Holdings." If you are unfamiliar with this company, it was formed in 2009 by Citigroup and operates as a subsidiary managing the financial risk that the company has been dealing with like all the other big banks. Since the fourth quarter of 2012, Citigroup has been able to reduce its home equity loan delinquencies from $7.48 billion to $5.45 billion- this is a 27% reduction in risk and one reason the company has done better. Along with an 11% increase in revenue year-over-year, the company is more profitable than it was a year ago.
JPMorgan Chase reported net income increase of 28% this quarter over the previous year. Reflected in this number is a combination of increased revenue and cost cutting measures. The reported net revenue of $2.7 billion was an increase of 15% over the previous year's reporting. Even though we had that big loss recorded in Europe last year, it has not damaged consumer interest in the bank. As reflected in the charts above, loans were up 22% from the prior-year and deposits were up 7% from the prior-year.
One notable move by Wells Fargo is worth mentioning, the bank has been a leader in domestic mortgages. As we experience a slowdown in the domestic mortgage market, it is looking elsewhere to continue to grow its revenue. By expanding its market in the United Kingdom, it is exploring ownership in the real estate lending division of Eurohypo U.K. from Commerzbank AG. This should help the bank grow out of this dependency upon the domestic market.
The four big banks in the "Money Center" industry continue to become more efficient as can be seen in their ratios. As the economy continues to grow, so should the deposits and loans that the banks give out to consumers and commercial customers. I realize the banks have grown quite a bit since the beginning of the year, but I am also of the opinion that they will continue to become more efficient and increase their revenues as the economy picks up.
Author's note: All charts were made on excel spreadsheet from statistics taken from each bank's quarterly earnings presentation.