Earnings Season
The earnings season is underway, with 129 banks and other financial sector companies having reported results for the second quarter of the current year. Revenues for most of the banks meet analyst estimates. However, earnings exceeded expectations, largely due to cost-cutting initiatives and improving U.S. housing markets. Our view is that banks that are able to further control their costs and have a large exposure to U.S. housing markets will flourish going forward. This thesis aims to look into details on top and bottom line surprises, and explore reasons for such surprises.
Overall, the financials have performed in line with expectations with regards to the top line. However, the bottom line has surpassed estimates, providing a surprise of 7%. Diversified financials witnessed the largest surprise of 11% in their bottom line, while insurance companies were the biggest losers. Their bottom line remained 7% below analyst estimates.
A similar trend was witnessed among the financials included in the S&P 500 index. Revenues of 26 financials remained in line with analyst expectations. However, earnings exceeded estimates for the same by 7%. Diversified financials remained the top performers with regards to their earnings, which exceeded expectations by 11%. Earnings from insurance companies remained 10% below expectations.
The table below shows a list of large cap banks that have reported their second quarter performances. Despite the challenging environment that these banks are operating in, they were able to meet or in some cases exceed analyst estimates as far as their earnings were concerned. This was largely due to their ambitious cost-cutting programs and improvements in the U.S. housing markets.
JPMorgan Chase (JPM)
JPMorgan Chase was the first bank to report its second quarter performance on July 13, 2012. Although the bank was able to surpass expectations by 5% as far as its top line was concerned, but its bottom line lagged behind by 5%. The bottom line largely suffered due to 'self-inflicted wounds'. The trading loss caused by London Whale has ballooned to $5.8b so far, as compared to the disclosed $2b. The troubled positions could add more losses of up to $1.7b, as predicted by Chief Financial Officer Doug Braunstein. The bank restated its prior quarter earnings, and accepted "material weakness" in the risk management systems being practiced at the bank's Chief Investment Office. Investors are concerned and will tend to stay away from the stock until the bank presents a clear picture on the actual loss suffered and its risk management systems; as well as until investigations conducted by several regulatory authorities reveal the truth. On the positive side, a solid performance was seen in the bank's investment banking and mortgage division. The stock has lost 14% of its market value since it first disclosed potential losses from its troubled positions.
Wells Fargo & Company (WFC)
The largest U.S. home lender remained 2% below analyst expectations with regards to its revenues and earnings for the second quarter. However, the results were certainly better than the prior quarters, as well as the prior years. The bank's community banking advanced by 8% and 20% QoQ and YoY, respectively. The surge in profits for community banking was largely due to improved mortgage originations and mortgage applications, supported by a growth in deposit service charges, trust & investment fees, and debit, credit & merchant card transaction volumes. The bank's cost-cutting program (Project Compass) also contributed $596mn in cost savings. WFC's stock appreciated by 3% the day that the second quarter results were announced. Our view is that the bank is optimally positioned to benefit from the improving U.S. housing markets.
Citigroup (C)
While Citigroup 's revenues fell 1% short of consensus estimates of $18.76b, its cost-cutting initiative helped to not just recover, but also surpass its earnings by 7% as compared to estimates. A closer look at the results reveals that the bank benefited from a combination of factors, including positive activity in the U.S. housing markets, the bank's ever-expanding global footprint and the cost cutting programs that it has embarked upon. The bank's gains on revenues from the Transactional Services segment, which grew by 5%, were partially offset by a decline of 2% in the Securities and Banking segment revenues. Owing to weak capital market activity, the bank's revenues from fixed income and equities fell by 41% and 39%, respectively. Revenues of $9.8b from Global Consumer Banking did not show any improvement over the prior quarter. We believe the bank's unparalleled global presence, along with its continued efforts to reduce costs to self-fund new investments will benefit it in the future.
Goldman Sachs (GS)
GS, the leader in investment banking, maintained its leadership after it released its performance for the year's second quarter. Although the results posted exceeded analyst estimates, they remained considerably below those of the prior quarters and the prior years. The bank's earnings per share dropped by over 50% to reach $1.78, compared to the prior quarter, while its revenues dropped by a third. Revenues accruing from the bank's Institutional & Client Services and Investing & Lending took a major hit and dropped by 32% and 90% as compared to the prior quarter. The bank's Investment Banking revenues increased by 4% owing to increased revenues from debt underwriting. As concluded in our previous report, Goldman's cost-cutting initiatives benefited it, and the bank ended up decreasing its operating expenses by 8%, compared to the prior quarter. Going forward, we still think the bank will experience a hard time ahead, which is why we are reiterating our sell rating on the stock.
Bank of American (BAC)
For the Bank of America, a similar trend was witnessed when they reported their second quarter performance. The reported net income of $2.5b was earned on $22b. While the revenues for the bank fell 1% short of analyst estimates, its earnings exceeded expectations by 13%. The fact that revenues were slightly short of the previous quarter's figures tells a lot about the challenging environment in which these banks are operating. Earnings significantly exceeded expectations on BAC's Project New (cost-cutting program) as well as mortgage banking income. Alternative banking channels, including mobile banking, played a key role in this improvement. A 34% growth YoY was seen in the bank's mobile banking customers, as customers move to more convenient channels of managing their savings. The bank extended $18b in residential mortgage loans. Under the New BAC project, the bank expects to save $8b annually by mid-2015.
Morgan Stanley (MS)
Morgan Stanley reported overall weak second quarter results on July 19, 2012. All the business segments recorded a decline in revenues, and the bank announced plans for layoffs. The share price fell 5% as soon as the results were reported. The results put a big question mark on the management's new focus on client business.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
