What To Expect From US Bank Earnings: JPMorgan, Citi, Well Fargo

Hey guys, Eddie here. Today we're going to be discussing bank earnings. So we've got Wells Fargo, JP Morgan, and Citigroup all reporting tomorrow. So should you be buying the banks right now? We're going to take a look at the 2020 year, we're going to take a look at what to expect from earnings, and we're going to take a look at the outlook going forward. But really, the sector suffered a terrible time during the coronavirus lockdown. So this basically threatened to spark a rush of loan defaults, and this led to a real, you know, a real drawdown in bank stocks and their share prices in that March-April period. Since then, they've recovered somewhat with names like Wells Fargo and JP Morgan almost doubling. And actually there's been a lot of good things and a lot of tailwinds for the banks and financial institutions over the last few weeks. Um, probably not more notable, uh, than of course the, the Pfizer and BioNTech vaccine on November the 9th, and that was obviously highly effective. They've actually— the US bank index has actually outperformed the wider market by about 25%. Since that date. And this is, uh, investors are searching for, you know, stocks really, uh, that are going to feel the benefit of the, the vaccine-led rebound. And of course, we've also had, uh, the prospect, uh, or actually the, the concrete result of the Democratic Party ruling the House, Senate, uh, and the White House, which is obviously, uh, going to allow them to pass legislation a lot easier. Uh, so this, what does this mean? This means more likelihood and a higher probability of stimulus checks, $2,000 rather than $600. And this is fueling inflation expectations, triggering, triggering a rise in the long-term interest rates. And this is good for banks' profits. Okay, Q4 net income that they're about to report year on year is going to be down, and I think revenues are also going to be down on a year-on-year basis. But there's a lot of positives and it's all about the outlook going forward. We're likely to get some reserve, reserve releases. So this is relating to an accounting process that actually boosts banks' profits by releasing those loan provisions that they set aside. And there was about $65 billion of those loan provisions that were set aside in last year, but mainly in that March-April period, to basically cover the potential for loan losses and delinquent loans. So this— the worst of the credit outcomes are really now off the table. There's still uncertainty, of course, of how the cycle will pan out. You know, will the viruses work? Will there be mutations? You know, will there be further and further rolling lockdowns? So, you know, we don't know that yet, but the outlook's certainly improved. We've also seen credit doing a lot better and actually their expenses remaining pretty much under control. There's also been a flood of investment banking activity, and I really think that's going to be a real hotspot tomorrow when they report. Trading, of course, benefited from the volatility that we saw in March and April and particularly in that kind of 2020 period. But And since then, when we've had more sanguine markets return, equity capital market activity has really benefited. So a rush of IPOs and we've seen record volumes, record SPAC volumes. So I really think, you know, especially the DCM activity was so strong as well in terms of companies looking for liquidity, really trying to shore up their capital structures in light of the pandemic. This is going to be a real bright spot for the investment banks particularly, and especially those banks that are more concentrated or derive a higher proportion of their revenues from those traditional investment banking activities. Even bankers never had a busier Christmas and New Year period. So there was lots and lots of M&A activity going through during that period. So lots and lots of fees being collected. What does a steepening yield curve really mean? Everyone says, oh yeah, still steeper yield curve is good for the banks. Okay, we've actually got the yield curve, uh, at a 4-year high now. This basically indicates stronger economic activity and rising inflation expectations, and thus higher interest rates. So when this yield curve is steep, banks are able to borrow money at lower interest rates and then lend at higher interest rates. So in theory, a steeper curve and more profit. So the short-term outlook for the economy It may be dark, but the bond investors are seeing a bright future and an improving outlook. And this steepening yield curve is a sign of economic recovery. Okay, so it's all really positive things why we're seeing this steeper yield curve. Okay, so lower default rates is another kind of, um, positive for the banks. Okay, but of course we need to talk about the Fed when we talk about the steeper yield curve. Uh, you know, what level does that yield curve have to get to, let's say, on the on the 10-year Treasury for the Fed to step in. Okay, but I think it's important to remember that, um, the Fed, just like in March, they don't just look at yields and they don't just look at the equity market. They look at a holistic, uh, kind of list of, uh, different parameters and different indicators before making decisions, right? So for example, the financial conditions. Okay, they look at risk, credit, leverage conditions in money markets, debt, equity markets, shadow banking systems. So they don't just look at yields, they'll look at all of them holistically. And actually, the, the basically financial conditions are as loose as they were in February. Okay, so just because we've seen this yield rise, it doesn't necessarily mean that the Fed are going to step in and actually put a ceiling on those yields, or so, so we expect. Okay, so in terms of the steeper yield curve, this is a positive for banks. Okay, it benefits their net interest margins and should boost the traditional banking activities as well as implicitly signaling a stronger economic growth path, you know, lower default rates, for example. Okay, love a discount. So US banks have a big discount since the vaccine breakthrough. You can see the little inflection point on the chart, but the coronavirus made this a lot— this poor performance that we've really seen since, let's say, 2017— a lot worse. And the KBW Bank Index lost a quarter of its value between late 2018 and late 2020, and this underperformed the S&P 500 by almost 50%. Okay, the P/E ratio of the banks is now about half of the wider markets, okay, which is high in terms of the rest of the market at the moment. But historically, the bank's discount has averaged 25%. So there is that kind of value gap to close if you look at it that way. So, um, the underperformance of those banks versus the overall market in 2020 was really at an extreme, okay? And you actually have to go all the way back to 2000, so the dot-com bubble— we all know what happened there— to find something similar. Okay, and then from there, um, it reversed and the banks outperformed for 8 years. Okay, so of course until the global financial crisis. Um, but if you look at this, it looks like there's a good opportunity here to close that value gap. One thing that will be another positive in terms of the banks is they've had a really strong end to the— the end of 2020, so Q4, and this has paved the way now for particularly America's top banks to buy back more than $10 billion of their own shares in this Q1 period to come. Okay, and of course this is because the loan losses are not as bad as first anticipated. We've got a vaccine, all the things that we've talked about before, um, especially investment banking, capital market activities being extremely buoyant. This has now allowed, um, the Fed to say, okay, you're allowed to buy back your own shares. Okay, and this comes back to the Fed's June stress test. They banned the buybacks until the end of 2020, and they capped dividends at a level linked to recent profits and payouts. So the first Q quarter, so Q1, that, that those repurchases will be capped to the sum of the dividends and buybacks, and they cannot exceed average quarterly earnings over the previous year. So JPMorgan, they're about to spend $3.2 billion, or forecasted, uh, on their own shares by the end of March. Okay, and $30 billion on that buyback program over an indefinite time frame. So this is going to be a kind of a multi-year, uh, period. And that— and a remaining $7.4 billion is going to be split across Bank of America, Citi, Goldman Sachs, Morgan Stanley, uh, and Wells Fargo. So banks' capital levels are getting stronger and stronger, and this is basically, uh, setting the scene for allowing them to now pay dividends and actually buy back their own shares. Okay, it's only about how aggressive are they going to be. But what does this lead to? This leads to artificially improving earnings per share. Okay, so you're removing the shares from circulation by buying them back, and this increases your earnings per share. You can look at a company like Apple that have aggressively bought back their own shares and kept beating on earnings per share estimates, for example, but actually their sales haven't improved that much, but their share price, uh, has gone through the roof. Okay, so this is definitely a positive for the banks. Okay, another positive amongst everything else. So in summary, Yields, inflation expectations are climbing, leading to a steeper yield curve from this kind of Democratic clean sweep, okay? And the virus, and there's a value gap to close. Um, credit conditions are doing better, financial conditions are loose, okay? Uh, capital markets activity and investment banking activity was very strong. So I think the outlook for the banks is going to be, uh, quite promising. Um, and I would be a buyer of these banks. So I hope you enjoyed the video. Okay, please like the video and subscribe to the channel if you enjoyed it for more content. But take care and see you soon.