The federal tax reform certainly contributes to the reports of higher-than-ever profits at three leading U.S. banks in their first quarter. Noticeably, JP Morgan Chase reported a 35% increase in net income from last year, making it the largest U.S. bank by assets. Chief Executive James Dimon believed that the results reflected both a sweeping increase in savings resulted from lower tax rates, and an anticipation for more economic growth and a more conducive business environment in the future. Stocks at major banks outperformed the market average since the 2016 presidential election. Yet, investors are intensely searching for reasons to make them increase further.
On the other hand, bank executives are worried that they might need to guarantee higher rates of return to retain investors, given an imminent increase in Federal Reserve’s interest rates. Some are also concerned that the political atmosphere, especially the threat of a U.S.-China trade war could jeopardize the recovery of the financial market. Yet, analysts seem to believe that the earnings from first quarter seem to suggest the otherwise. Citigroup CEO Michael Corbat believed that despite the uncertainty generated by President Trump’s morning tweets and varying stances taken by the administration, the bright sides still outshine the shadows.
Big Banks Post Strong Results but Investors Want More
Lower taxes, a boost in lending income and a flurry of trading activity sparked by market volatility propelled profits higher at three of the U.S.’s biggest banks in the first quarter.
JPMorgan Chase JPM -2.71% & Co. led the charge, reporting net income of $8.7 billion—up 35% from a year earlier and a record for the largest U.S. bank by assets. While the performance benefited from a quarter-billion dollar in savings from a lower tax rate, Chief Executive James Dimon said the results also reflected a brightening economic and business environment.
“The global economy continues to do well, and we remain optimistic about the positive impact of tax reform in the U.S. as business sentiment remains upbeat, and consumers benefit from job and wage growth,” he said in the bank’s earnings release.
Despite the strong earnings, investors sent shares lower on signs of tepid loan growth, particularly from businesses, and a lack of new earnings drivers after a run-up in valuations.
The brighter economic conditions also helped Citigroup Inc. C -1.55% It reported that net income rose 13% from a year earlier to $4.62 billion, while its return on equity, a closely watched measure of bank profitability, was at its highest level in five years.
Wells Fargo WFC -3.43% & Co. said its first-quarter profit rose 5% to $5.9 billion, although it cautioned that it might need to restate those results because of a looming regulatory settlement that could be as high as $1 billion.
PNC Financial Services Group Inc., PNC -4.14% the nation’s eighth-largest bank by assets, reported a 16% rise in earnings thanks to rising interest rates and commercial-lending growth.
While the banks largely met, or in some cases exceeded expectations, shares of JPMorgan fell more than 2% and Wells Fargo was down by more than 3%.
Bank stocks have outperformed the broader market since the November 2016 presidential election. Now, investors are looking for reasons for them to rise further, something that was lacking in the most-recent results.
“Bank stocks are at a point now where valuations are similar to 2007,” said James Shanahan, senior equity research analyst at retail brokerage Edward Jones. “It feels like there needs to be a really strong catalyst to propel them higher from here.”
Investors, for instance, are anticipating an acceleration in industry loan growth as the year progresses, said Jason Benowitz, senior portfolio manager at Roosevelt Investment Group Inc. and an investor in JPMorgan. “But this was not the tone” on bank earnings calls, he added.
Loan volume, especially for businesses, was on the rise at JPMorgan, Citigroup and PNC. But growth remained below levels of a few years ago. Bank executives said the tax overhaul passed late last year hasn’t yet had a pronounced effect on companies’ willingness to borrow.
“I think we have to recognize that tax reform is in its early stages,” Marianne Lake, JPMorgan’s finance chief, said on a call with reporters.
PNC CEO William Demchak said the lower tax rate may also crimp some areas of commercial lending. Companies will have more money on hand, which could reduce their need for bank loans, he added in an interview.
For the banks themselves, the tax overhaul is already flowing through to their bottom lines. JPMorgan reported an effective tax rate of 18% in the first quarter, down from 23% a year earlier. Citigroup’s effective tax rate fell to 24% from 31%, and Wells Fargo’s dropped to 19% from 27%.
The lower taxes helped boost banks’ return on equity. At JPMorgan, this measure of profitability hit 15% in the quarter, its highest level in years. Citigroup’s return of 9.7% was within striking distance of 10%, a psychologically important level for investors.
The gauge of profitability also was bolstered by banks’ continued return of capital to investors. JPMorgan said it returned $6.7 billion during the quarter through share buybacks and dividend payments. Combined, it, Citi and Wells Fargo have returned nearly $60 billion to investors over the past four quarters.
Besides the boost from taxes, banks’ businesses mostly remained solid, even if growth isn’t spectacular.
Rising interest rates have helped bolster net interest margins, which measure how profitably banks put depositors’ money into loans and securities. They expanded at JPMorgan and Citigroup, reversing years of declines.
Yet analysts expect banks will soon have to pay more for deposits to keep customers from shifting funds elsewhere, especially if the Federal Reserve continues to increase rates. That could pressure those margins.
The prospect of sharply higher interest rates also sparked market gyrations during the first quarter. The ensuing volatility in stock markets was a boon for bank trading desks. Equities-trading revenue rose 38% to $1.1 billion at Citigroup, the best in seven years, and 26% to a record $2 billion at JPMorgan.
In bond markets, however, volatility kept money managers on the sidelines. JPMorgan’s revenue for that unit was flat, excluding accounting adjustments, while Citigroup’s was down 7% versus a year earlier.
Market upheaval also depressed investment-banking activity as companies were spooked by the prospect of issuing additional bonds in choppy markets. Debt-underwriting fees fell 18% at JPMorgan and 8% at Citigroup. “Significant volatility isn’t helpful,” Citigroup CFO John Gerspach said on a conference call with reporters.
While markets were unsettled during the quarter, the political atmosphere was particularly tumultuous. Citigroup said, though, that things like the threat of a U.S.-China trade war hadn’t so far crimped global activity. Rather, the bank has experienced higher revenue in both consumer and corporate banking, especially in Asia and Latin America.
“The volatility we see from morning tweets, or stances that vary from time to time—I won’t say the world is numb or numbing to that, but the positive things happening are overwhelming that,” CEO Michael Corbat told analysts.
Source: The Wall Street Journal, Peter Rudegeair and Telis Demos, April 13, 2018. Photo credit to The Wall Street Journal.