- Revenue growth remains flat, more expense reductions needed.
- Loan-loss reserves are driving EPS growth.
- Top-line growth is a sector issue, not just JPM and WFC.
These are very different banks, but I chose to combine the earnings previews since the state of the financial sector as evidenced by CCAR (Comprehensive Capital and Analysis Review), Dodd-Frank regulation, etc. have (in my opinion) left the large banks and SIFIs (strategically important financial institution) as effective public utilities rather than competitive, dynamic, conduits between savers and lenders.
Let's look at each bank individually in terms of the earnings preview and then draw some conclusions at the end of the article:
Jamie Dimon's nightmare seems to never end, particularly in the mainstream and financial media, as recent key employee departures at the bank are being discussed at CNBC as this is being written.
Personally, I think JPM and Jamie Dimon are fine, but it is the macro and what the bank can't control that is killing them.
Analyst consensus for JPM coming into Friday's release are expecting $1.41 in earnings per share (EPS) on $24.56 billion in revenue, for year-over-year declines in EPS of -11% and revenues of -5%.
The consensus estimates have gradually declined since the q4 '13 earnings report was released in mid-January.
For full year, 2014, the current consensus estimate for JPM is $5.88 per share, which if you exclude the q3 '13 litigation charge and assume that q3 '13's "core EPS" was roughly $1.20-$1.24, then 2013's full year EPS, on an operating basis, was $5.90 to $5.95, which means that current consensus is expecting a decline in EPS on an operating basis in 2014. (Any reference to consensus earnings and revenue estimates is sourced from Thomson Reuters).
Looking at revenues, which aren't impacted by the litigation charges in 2013, actual revenue growth was flat in 2013, coming in at $99.8 billion for the full year versus $99.9 billion of revenue for 2012, and for full year 2014, the Street consensus is currently expecting $99.7 billion in revenues, except that the revisions have been steadily lower.
Recent CCAR news from March 26th detailed that JPM could increase the dividend to $0.40 per share starting in q1 '14 and institute a $6.5 billion share repurchase plan. That is good news, but I think a lot of it was in the stock when the news hit.
The reason JPM could grow EPS 14% in 2013 on flat revenue growth is that the banking sector has been living off loan-loss reserve releases (LLR) which soared after 2008 and 2009. Given some of the detail in the earnings release, I estimate JPM's LLR added $0.30-$0.35 to q4 '13 EPS, and I suspect that well is starting to run dry looking at some industry data.
In other words, as LLRs start to temper or no reserves are released at all, the banks will start having to substitute revenue growth to drive earnings growth.
JPM's stock rose 33% in 2013. My own opinion is 2014 is a much tougher year for the banks as expense-driven earnings growth becomes tougher, and revenue growth under the heavily-regulated environment becomes tougher still.
JPM's business segment revenues are roughly 35%-45% each Consumer Banking and the Investment Bank, with the rest being the smaller segments of Asset Management and Commercial Banking.
The dividend and the share repo plan are a nice bonus to early 2014. $6.5 billion at $60 per share currently means JPM could buy back 108 million shares or roughly 3% of the current shares outstanding. As is typical of the new environment, that really isn't much to write home about.
When WFC reports its q1 '14 results on Friday morning, April 11th, analyst consensus will be expecting $0.96 in EPS on $20.6 billion in revenue for expected year-over-year growth of 4% in earnings on a 3% revenue decline.
WFC also received favorable news on March 26th from CCAR, as it looks like WFC saw a bigger-than-expected capital return approved of $24 billion, including a 17% dividend increase.
Unlike JPMorgan's diverse revenue stream, WFC's fortunes are tied to the mortgage business, and the prospects have been dimming for mortgage origination and refi's as rates rose in 2013.
WFC is thought to have a 33%-35% market share of the mortgage origination market, so higher rates, while a positive for the net Interest Income (NIM) margin is a negative for origination fees, etc.
Average loan growth did improve 6% sequentially in q4 '13 even though core mortgage revenues fell 54% year-over-year at the mortgage giant.
However, continuing with the above theme on LLRs, it looks as if Wells Fargo's LLR release in q4 '13 added between $0.12 and $0.14 per share.
The point being that JPM's q4 '13 LLR represented about 23%-25% of JPM's q4 '13 EPS while WFC's LLR release represented about half that or 12% of WFC's q4 '13 EPS.
For the full year 2014, current Street consensus for WFC is expecting 1% revenue growth and 4% EPS growth, and that is probably contingent on the mortgage market not slowing further.
The problem with the Financial sector is that there just is no revenue growth across the banking system. Mortgage credit dried up immediately after 2008 and 2009, which is understandable, and now the underwriting standards are much tougher to get a single-family loan. While the credit markets have been strong, I would imagine that has taken some juice out of the commercial loan market. S&P 500 businesses are flush with cash and cash flow and have used that cash to repo stock and boost dividends. Combine this with the "genital cuff" Dodd-Frank and Washington regulators have placed around the banking system (to borrow a humorous term from Michael Caine and Steve Martin, who both starred in, "Dirty, Rotten Scoundrels") and the US banking system must now hold more capital and take far less risk with their balance sheets, and the banks must go hat-in-hand to get "permission" from the Fed to pay dividends and repo shares.
Frankly I think this is going to reduce ROEs for the major US banks.
The big banks have functionally become utilities. (We addressed this in our recent blog post, and noted who we think the winners will be, but haven't flushed the numbers out yet.)
Finally, I think JPM and WFC are in good shape, but growing revenues when the expense line-items dry-up will be a challenge. We've always liked investing in the Financial sector - we understand the dynamics and how the sector works, but outperformance might be tough to come by.
I think you'll need to see wholesale changes in Washington and pro-business policies again (and it could come from Hillary) before the banks are able to generate revenue growth which doesn't make the regulators head spin around like the girl in the Exorcist.