Q4 Earnings Update: JPM, Citi & WFC

New York | Last week, JPMorganChase (NYSE:JPM), Citigroup (NYSE:C) and Wells Fargo & Co (NYSE:WFC) reported Q4 2020 earnings. As the folks at KBW told The Wall Street Journal last week, it was a messy quarter, both for what was disclosed to investors and what was not disclosed. The major themes of fourth quarter results are 1) declining estimates for bank credit costs, partly due to the Cares Act and other consumer and business debt moratoria, and 2) weaker interest income and revenue for banks going into 2021.

Financials Group: ALLY, AXP, BAC, BK, C, COF, DB, DFS, FRC, GS, HSBA, JPM, MS, OZK, PNC, PYPL, SCHW, SQ, TD, TFC, USB, WFC

JPMorgan

For JPM, the bank’s net income was down 20% for the year vs 2019, a fact that did not prevent investors from driving bank shares up to pre-COVID levels. JPM closed on Friday at 1.7x book, a fairly rich valuation given the bank’s modest earnings prospects for the coming year.

The Street analyst consensus has revenue at JPM falling mid-single digits in 2021. The fact of an almost 30bp decline in JPM’s interest rate spread, this even as deposits rose by more than 1/3rd, illustrates the negative impact of QE on bank earnings.

The big “surprise” in JPM’s earnings was the $1.9 billion release of loss provisions back into income, a signal that on the consumer side, at least, the credit picture is relatively benign despite the damage being done to many sectors. Simply stated, the people who are suffering the most from COVID do not seem to be big users of consumer credit. Credit losses remain moderate, yet other factors pushed consumer & retail net income at JPM down 50% YOY.

In commercial credit, however, the story is different. Net income for the corporate and investment bank was up 40% YOY. While JPM did release some loan loss provisions from C&I loans, the reserves for commercial loan loss exposures remain up tenfold vs the end of 2019. The big banks are not done dealing with the credit fallout from COVID in commercial exposures, we are simply pausing the credit build.

We expect that JPM will maintain the current levels of provisions until the bank has greater visibility on actual commercial losses going forward. Loss provisions overall were up over 215% in 2020 after the Q4 reserve release, suggesting significant credit costs lie ahead. Net charge-offs were up 151% for 2020, but still tiny in absolute dollar terms at 0.76% of total loans vs 0.46% for Peer Group One.

Citigroup

Like JPM, Citi also saw a decline in net income during 2020. But Citi is trading at less than half of the book value multiple of JPM, just 0.75x book as of Friday’s close. Of greater concern, however, was the slide in operating efficiency in Q4, going from the mid-50s to almost 65% efficiency at year end. Perhaps the increase in operating costs was associated with the 5% surge in headcount? Total assets grew 16% in 2020 while tangible book value rose just 5%.

While interest expense fell 61% over the course of 2020, interest income fell 30%, illustrating the wasting effect of current FOMC policy on bank margins. Net interest revenue fell 13% in 2020 while net revenue was down 10% Q4 2019 to Q4 2020. Most important, net credit losses at Citi fell 24% or $500 million in Q4, again illustrating the impact of the Cares Act and state debt moratoria on the apparent credit standing of major banks.

We expect these numbers to go up as moratoria expire, but we also see a generally good credit situation vs the fears we voiced back in March and April. The imponderable is employment and the potential for a sustained dip in 2021, something that could again elevate concerns about credit.

Citi released $1.8 billion from loss provisions back into earnings in Q4, leaving total reserves just shy of $16 billion vs $8 billion at the end of 2019. Even with that positive, however, Citi’s net income was down 41% vs full year 2019. If you bought the stock in 2020, you are paying 2019 prices for half the revenue. This is why we own the Citi preferred rather than the common, of note.

Like JPM, Citi saw its global consumer banking segment decline broadly on the revenue line and almost reported negative earnings for the year. The institutional clients group, however, saw revenue rise almost 30% on strong North America activity but missed on earnings. Ironically, overall net revenue for C was virtually unchanged from 2019.

Wells Fargo & Co

After an awful year, WFC did better on earnings in Q4 2020, but that did not prevent the bank from delivering a down 90% result on the net income line for the full year. The bank’s common shares closed Friday at 0.8x book value or half the book value multiple of JPM. WFC managed a reserve release that was 1/10th the size of JPM. Even with the modest release, WFC’s loss provisions ended 2020 at $14.1 billion, up 426% for 2020.

WFC shrunk in terms of revenue and operations, particularly with the announcement of the closure of the bank’s offshore advisory business. We expect to see a further charge for the shut-down of the WFC non-US advisory business, which apparently had such a large proportion of clients from Venezuela that the business was judged to be unsalable.

Of note, WFC’s mortgage servicing business continues to shrink. The fair value of the WFC mortgage servicing rights declined 43% over the past year. Mortgage banking revenue was up in 2020 as you might expect given the huge boom in residential lending, but the fact remains that WFC’s once 1/3 market share in residential mortgage servicing is running off rapidly.

Meanwhile, WFC loaded up on derivatives, which grew 80% YOY, and saw large gains on trading securities, up more than 500% YOY. Net interest income for WFC, however, fell 16% through Q4 2020.

We expect to see depressed revenue and operating margins for much of 2021, both due to the economic malaise caused by COVID and the growing negative impact on bank earnings due to QE. Unless and until the FOMC relents and eases up on its massive purchases of Treasury securities and MBS, bank earnings are likely to decline further. The long-term damage to banks and the rest of the US financial system from the Fed's radical policies is incalculable.

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