Big Banks’ Earnings Fit for Goldilocks

by Dan Burrows | April 19, 2012 3:40 pm

Judging by the market’s reaction to the big banks’ earnings so far this season, the results have neither been too hot, nor too cold, but just about right.

The financial sector was forecast to have some of the best year-over-year earnings growth during an other wise lackluster first quarter. At the same time, analysts’ expectations were low for all corporate profits heading into the reporting season, leaving little excuse for firms to miss estimates.

Meanwhile, the KBW Bank Index (BKX) was up about 16% for the year-do-date vs. 8% for the S&P 500 when the reporting season began. After an initial lift, it has remained right about where it started. It seems expectations in the aggregate have been neither eclipsed nor dashed.

All things considered, that’s not a bad place for an investor in financial stocks to be.

It also makes a lot of sense, given that it has been a quarter of incremental improvement so far for big bank earnings. Even when firms have missed Wall Street estimates or failed to wow traders, business has shown to be slowly improving for the most part.

Banks are setting less money aside for bad loans, for one thing. They’re also generating more loans in general and, yes, seeing signs of a thaw in the housing market. Furthermore, among the players on Wall Street, profits from trading, advising on deals and underwriting stock and bond offerings are picking up.

That helps explain why even in cases where a big bank reported declines in profit and revenue, traders found signs of life and shares got a lift. Troubled Citigroup (NYSE:C[1]), for example, posted a drop in earnings, yet shares jumped more than 3%, helped by better-than-expected results from trading and deal activity.

At both JPMorgan Chase (NYSE:JPM[2]) and Wells Fargo (NYSE:WFC[3]) the nation’s healthiest banks kicked off earnings season by beating the Street’s top- and bottom-line forecasts. The firms were able to set aside less money to cover bad loans in the future. Furthermore, loan growth ticked up and the quality of the banks’ assets improved.

Bank of America (NYSE:BAC[4]) and Morgan Stanley (NYSE:MS[5]) both beat the Street when they reported Thursday. Like other names, BofA benefited from healthier consumers, as it took lower losses on consumer credit. BofA and Morgan Stanley alike enjoyed more business on Wall Street. Like Goldman Sachs (NYSE:GS[6]), the firms saw increased sales, underwriting and trading activity — something that had been sleepy for several quarters.

True, banks are by no means out of trouble. It’s more a case where incremental improvements in some areas of business are militating against continued weakness in others. BofA, for example, continues to be hampered by mortgages. At Citigroup, demand for loans in emerging markets has stayed robust, but the U.S. and Europe still are tepid, hurt by uncertainty and, in the latter case, recession.

Also, let’s not forget that stocks soared in the first quarter, giving a boost to wealth management operations at places such as Morgan Stanley — a phenomenon that looks unlikely to repeat itself in the second quarter.

Ultimately, first-quarter earnings haven’t been too bad for the nation’s big banks, and trading activity suggests shares might have even found a floor, say analysts at Keefe, Bruyette & Woods. Fewer and fewer bank stocks are trading below price-to-tangible book value, notes KBW analyst Frederick Cannon, in a new report to clients. U.S. financial asset values have stabilized, Cannon says, and the April weakness in financial stocks must be seen as a correction.

“As the group is still up more than 15% year to date. U.S. economic conditions and earnings will determine the overall movement in the group going forward,” the analyst writes.

First-quarter results might not be sounding the all-clear, but they’re not sending investors into the bomb shelters, either. Like the broader economy, the sector appears to be muddling through — and at this point, that seems to be just about good enough.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

  1. C:
  2. JPM:
  3. WFC:
  4. BAC:
  5. MS:
  6. GS:

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