Opinion: ‘This is going to hurt’ — pain is on the way for the four big U.S. banks
[MarketWatch]
The four largest U.S. banks posted profits in the first quarter, even though they set aside billions of dollars for expected loan losses. Some analysts referred to the hit on earnings as “noise” because the banks simply moved money from one bucket to another.
Chris Kotowski, a bank analyst at Oppenheimer, referred to large quarterly provisions for loan losses (that is, additions to loan loss reserves) as “reserve noise” that lacks “economic substance” in reports April 14 and 15 for the simple reason that the largest banks haven’t yet taken significant credit losses from the economic turmoil caused by the coronavirus outbreak.
Kotowski also pointed out that the first quarter didn’t result in the largest banks taking significant trading losses as the Federal Reserve’s 2019 stress tests predicted in their “severely adverse” economic scenario.
Edward Jones analyst James Shanahan said in an interview that the trading business has been serving the banks well in a difficult environment because “it diversifies their sources of earnings.”
Prudent provisions
But maybe setting aside a lot of money in anticipation of loan losses is prudent, necessary and not a distraction. Bank regulators frown upon over-reserving, because it can lead to a smoothing-out of earnings if a bank under-reserves during subsequent quarters.
The banks made large provisions for loan losses in the first quarter because they expected eventually to take the losses. The economic crisis really didn’t hit home until mid-March, so first-quarter loan-loss figures remained low, while expectations mounted that the second quarter would be brutal.
Mark Doctoroff of Mitsubishi UFJ Financial Group (MUFG), who is based in New York and co-heads the global financial institutions group within corporate and investment banking, said he was “not surprised” the largest U.S. banks had set aside so much for reserves during the first quarter.
“The banks can easily afford it this time, as opposed to last time,” he said during an interview April 15, referring to the 2008 credit crisis.
“Taking out the credit and exceptional items, it is not as if it was a bad quarter,” Doctoroff said, echoing what Kotowski and other analysts wrote in their client notes this week. But Doctoroff also said “this is going to hurt a lot more,” with the most important unknown being “how long this lasts.”
J.P. Morgan’s dire ‘base case’
During J.P. Morgan Chase’s JPM, +1.63% earnings call April 14, Wells Fargo analyst Mike Mayo asked the bank’s CEO James Dimon to define the economic “base case” that justified the buildup of loan loss reserves.
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Dimon said: “We’re talking about June, July, August — something like that” for the lifting of restrictions.
J.P. Morgan CFO Jennifer Piepszak addressed the “base case” by saying that after initially factoring in an annualized 25% GDP decline and 10% unemployment for the second quarter, the bank’s economists had “updated their outlook and now have GDP down 40% in the second quarter and unemployment at 20%,” according to a transcript provided by FactSet.
Those figures are by no means unreasonable. This week’s initial jobless claims report brought the total to more than 20 million, creating a 15% unemployment rate estimate.
That said, there are many moving parts. Later in the call, after Kotowski asked whether federal and regulatory relief efforts for borrowers might “push back the charge-off curve,” Piepszak responded: “It may, because as long as a customer is performing under the forbearance program, they are not delinquent. But,of course, it will all depend on whether these programs ultimately are able to bridge people back to employment.”
Clean credit in the first quarter
Here’s a summary of how the provisions for loan losses lowered first-quarter earnings for the largest four U.S. banks, with all numbers in millions:
| BANK | TICKER | PROVISION FOR LOAN LOSSES – Q1, 2020 | PROVISION FOR LOAN LOSSES – Q4, 2019 | PROVISIONS FOR LOAN LOSSES – Q1, 2019 |
| J.P. Morgan Chase & Co. | JPM, +1.63% | $8,245 | $1,427 | $1,495 |
| Bank of America Corp. | BAC, +3.19% | $4,761 | $941 | $1,013 |
| Citigroup Inc. | C, +3.76% | $7,027 | $2,222 | $1,980 |
| Wells Fargo & Co. | WFC, +0.79% | $1,718 | $522 | $710 |
| Source: company filings |
| BANK | TICKER | NET INCOME – Q1, 2020 | NET INCOME – Q4, 2019 | NET INCOME – Q1, 2019 |
| J.P. Morgan Chase & Co. | JPM, +1.63% | $2,865 | $8,520 | $9,179 |
| Bank of America Corp | BAC, +3.19% | $4,010 | $6,994 | $7,311 |
| Citigroup Inc. | C, +3.76% | $2,522 | $4,979 | $4,710 |
| Wells Fargo & Co. | WFC, +0.79% | $653 | $2,873 | $5,860 |
| Source: company filings |
You can click on the tickers for more about each company, including news coverage.
You will have to scroll the tables to see all the data.
Note: The net income figures are before preferred-stock dividends.
Here are some common credit measures, showing that the banks were certainly looking ahead while setting aside so much for loan loss reserves, backing Kotowski’s “noise” comments.
The first is nonaccrual loans to total loans. A loan is placed in nonaccrual status if the lender is no longer confident that principal and interest will be repaid. The loan can stay in this status for some time before it is charged-off as a loss. Consumer loans will be carried in “performing” but delinquent categories of past due 30-89 days and past due 90-plus days before being placed in nonaccrual. A commercial loan may be categorized quickly as nonaccrual if it cannot be renewed or if there is some other credit event making its repayment doubtful.
| BANK | NONACCRUAL LOANS/TOTAL LOANS – MARCH 31, 2020 | NONACCRUAL LOANS/TOTAL LOANS – DEC. 31, 2019 | NONACCRUAL LOANS/TOTAL LOANS – MARCH 31, 2019 |
| J.P. Morgan Chase & Co. | 0.59% | 0.43% | 0.55% |
| Bank of America Corp | 0.39% | 0.36% | 0.52% |
| Citigroup Inc. | 0.58% | 0.57% | 0.54% |
| Wells Fargo & Co. | 0.61% | 0.56% | 0.73% |
| Source: company filings |
So there was only an uptick in nonaccruals, sequentially.
Next is net charge-offs to average loans. Net charge-offs are loan losses minus recoveries. After charging-off a loan, a bank may recover some of the loss by repossessing and disposing of collateral. You can see that net charge-offs remained low during the first quarter:
| BANK | NET CHARGE-OFFS/AVERAGE LOANS – Q1, 2020 | NET CHARGE-OFFS/AVERAGE LOANS – Q4, 2019 | NET CHARGE-OFFS/AVERAGE LOANS – Q1, 2019 |
| J.P. Morgan Chase & Co. | 0.62% | 0.63% | 0.58% |
| Bank of America Corp | 0.46% | 0.39% | 0.43% |
| Citigroup Inc. | 0.30% | 0.28% | 0.29% |
| Wells Fargo & Co. | 0.38% | 0.32% | 0.30% |
| Source: company filings |
Most of the big four banks saw a small increase in net charge-offs but these are low figures, especially when compared with the banks’ rising reserve coverage:
| BANK | LOAN LOSS RESERVES/TOTAL LOANS – MARCH 31, 2020 | LOAN LOSS RESERVES/TOTAL LOANS – DEC. 31, 2019 | LOAN LOSS RESERVES/TOTAL LOANS – MARCH 31, 2019 |
| J.P. Morgan Chase & Co. | 2.32% | 1.39% | 1.43% |
| Bank of America Corp | 1.51% | 0.97% | 1.02% |
| Citigroup Inc. | 2.91% | 1.84% | 1.82% |
| Wells Fargo & Co. | 1.19% | 1.09% | 1.14% |
| Source: company filings |
This last chart is interesting, because it shows that Citigroup C, +3.76% has set aside more reserves than the others, reflecting greater international and credit-card exposure. JPM’s high reserve set-aside reflects the dreadful economic scenario in the “base case,” as described above by Piepszak.
Wells Fargo WFC, +0.79% has the lowest level of reserves, which reflects in part the restrictions against balance-sheet expansion the bank has been operating under since early 2018, in the wake of several customer-service problems and investigations in its retail, loan servicing and wealth management divisions.
The Federal Reserve eased some of the restrictions in April, to allow the bank to increase its lending to small businesses, but Doctoroff believes it is time for the regulators to unleash Wells Fargo completely.
“They obviously want to increase lending. If you want to win a war, you have to be all-in,” he said.
“Banks can be good actors in this,” he added. “We are all trying to be. It is about helping our clients, putting the government money out there. I hope it continues.”
Shanahan of Edward Jones said banks’ mortgage loan forbearance efforts, which are backed by the CARES Act, are a good thing, “especially if you think the magnitude and timing for the economic recovery is favorable.”
But he worries that for some borrowers who will be unable to get their jobs back, “you are kicking the can.” The banks are “extending relief” to most types of borrowers, he added, while saying “they are likely to mitigate losses over time.”
“I am not worried about the banks going under — I am not worried about a 2008 scenario,” Doctoroff said. “But if this lasts more than a year, or year and a half, you are going to see some problems in [banking] too.”