Big Banks: What to Look for in This Week’s Earnings
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The Fiscal Times
January 14, 2013

While Wells Fargo (NYSE: WFC) got the banking sector’s fourth-quarter earnings season off to a good start last week, all eyes will be on the reports due this week from the likes of Bank of America (NYSE:BAC), JPMorgan Chase (NYSE: JPM) and Goldman Sachs (NYSE: GS).

These heavyweight players will report results that will give investors a mirror not only into the health and wellbeing of the individual institutions and their sector, but the economy as a whole. Is the housing recovery solidly on track? That will show up in details the banks will disclose about their mortgage lending. How confident and stable are consumers, financially speaking? Look for data on credit card lending, consumer lending – and on the related rate at which banks are setting aside provisions to deal with losses on those loans. What about companies – are ultra-low interest rates tempting them to borrow and expand? Everything from underwriting fees to small business loans tell a tale.

The absolute bottom line – earnings after one-time charges – won’t look that rosy, especially in light of Bank of America’s announcement that it had settled its long-standing spat with Fannie Mae over mortgages. That deal will result in a charge of $11.2 billion. Unsurprisingly, analysts promptly slashed their forecasts for the bank’s earnings from 18 cents to 2 cents a share, as computed by Thomson Reuters. So large and significant a player is Bank of America in the S&P 500 that that was enough to send the blended earnings growth estimate for the index for the fourth quarter to 1.9 percent from 2.8 percent.

But the impact of this settlement on the bank’s fourth-quarter bottom line is far from the most significant number when it comes to what we should be thinking about in the future. Similarly, Wells Fargo’s beating analysts’ estimates by three cents a share has limited value in projecting what lies ahead. Yes, the magnitude of the gain in earnings is good news – profits of 92 cents a share represented a 26 percent gain – but analysts will be digging more deeply into the operating results and trying to gauge what they mean for 2013 and beyond. That’s important to the future direction of bank stocks, which wrapped up 2012 posting some fairly healthy gains and outpacing the S&P 500 index as a whole.

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Investors want to know what’s coming up – the stock price says more about their future expectations than it does about past results. And there were a few worrying signs in Wells Fargo’s earnings release.

First of all, mortgage originations tumbled about 10 percent over the course of the fourth quarter from the end of the third quarter; the mortgage pipeline – loans that haven’t yet closed – also fell, for the second quarter running, and by a more significant 16 percent. With only one major mortgage lender having reported its results, it’s hard to tell whether this tells us something worrying about the mortgage market broadly – that the refinancing boom is drawing to a close and that the demand for new home loans by potential buyers also is faltering – or simply about the bank’s specific business.

Is Wells Fargo losing market share to rivals? Has it adopted tighter lending standards? Or have most of those homebuyers who qualify for a mortgage loan and who are interested in purchasing a property have already forged ahead? Are other homeowners not being lured to refinance by low interest rates? By the end of this week, we should have a clearer sense of what is happening.

Also troubling is the ratio of loans to deposits at Wells Fargo: for every $1 the bank attracts, 80 cents is being loaned out, while the remaining 20 cents sits within the bank’s coffers. That’s worrying on several fronts. It’s bad news for the bank, since interest rates are so low that it needs to put every dollar to work that it can in order to earn a respectable rate of return. (Right now, Wells reported its net interest margin fell further, to only 3.56 percent.) A surge in deposits on an absolute basis may signal an uneasy view on the part of consumers; one that isn’t offset by a similar uptick in lending activity can further shed light on risk aversion by potential borrowers or on a potential decline in credit quality.

When it comes to some of these banks – especially Goldman Sachs and Morgan Stanley (NYSE: MS) – what matters is underwriting and trading. Goldman benefitted from trading on behalf of clients in mortgages in the third quarter; investors will want to look for signs that regardless of what is happening to origination, trading volumes remained robust. They’ll also be looking more intensively at trading in general: Did all that fourth-quarter uncertainty surrounding the fiscal cliff keep trading clients on the sidelines? And if so, will we see a repeat as the first quarter draws to an end, as Washington again needs to hammer out a budget deal? Equity underwriting wasn’t all that robust in the fourth quarter, however, and while companies have been rushing to issue debt, fees on that kind of underwriting aren’t something that an investment bank can live off for long. Morgan Stanley, at least, has sent a worrying sign with last week’s reports of looming job cuts.

The bottom line for investors? Look past the bank’s earnings per share announcements and scrutinize details of their operations. While resolving legacy issues likely will remain an issue for most big banks, their ability to thrive will hinge on their core businesses’ ability to generate income and profits. Last year was a great year to invest in bank stocks, but that’s largely because 2011 was so crummy – and the best performers from amongst those bank stocks were those that had the most ground to make up, such as Citigroup (NYSE: C).

It’s time to be more selective, and try to identify those financial institutions with the fewest legacy issues, the most solid operating businesses and the greatest potential for generating improved returns on assets and equity without pushing the risk envelope too far. 

Business journalist Suzanne McGee spent more than 13 years at The Wall Street Journal before turning to freelance writing. Author of the book Chasing Goldman Sachs, she has written for Barron’s, The Financial Times, and Institutional Investor.