Bank Earnings: JPM, WFC & Citi

July 15, 2023 | Premium Service | A quick note to our Premium Service subscribers about Q1 2023 bank earnings so far. We’ve seen the best of the large bank group with JPMorgan (JPM), which as we wrote earlier is leading the top five money center banks by a wide margin. The mainstream media narrative says that banks are “benefiting from higher interest rates," but in fact funding costs rose less rapidly than feared. We'll take good news of whatever description.

The first key takeaway is that the rate of increase in funding costs has slowed, taking pressure off of the banks and also members of the Federal Open Market Committee. Looking at Citigroup (C), for example, the bank actually managed to push its gross loan yield to 8.6% while the gross cost of its deposits rose over 3%. Interest income overall rose 11% vs Q1 2023, while funding costs overall at Citi rose 17% vs Q1 2023. YOY, Citi’s funding costs are up over 400%, but Citi’s IR team thinks this statistic is not meaningful. The table below is from Citi’s Q2 2023 earnings presentation.

Citi’s credit expenses went down in Q2 2023, but operating expenses rose and revenue fell, resulting in a 37% drop in earnings vs Q1 2023, which is usually C’s best quarter of the year. A $1.5 billion drop in principal transactions was somewhat offset by lower loan loss reserves, but the bottom line was another disappointment for Citi shareholders.

Interest expense at JPM overall rose “only” 22% in Q2 2023 while interest income rose 13%, again showing the uphill climb against funding costs banks still face. JPM easily beat the other four money centers and seemingly maintained the 10 point operating leverage advantage over Peer Group 1. Again, low default rates allowed JPM to reduce loan loss provisions in Q2 2023, another significant tailwind for banks this quarter. Credit expenses may increase through the year.

Notice in the JPM earnings that deposit related fees rose 11% in Q2 2023, a reflection of the vast amount of funding that moved to the bank after the three bank failures in Q1 2023. One of our readers notes that the .01% PPI headline this month was totally dependent on the +0.2% contribution it got from Services. In turn, Services was supported by something called “Deposit Services” which posted +5.4% month-over-month.

JPM saw strong +26% growth in income from the mortgage sector, including the bank’s growing book of mortgage servicing rights. As we note in our latest column in National Mortgage News (“The chaos wrought by the FOMC keeps unfolding”), JPM is well-positioned to buy conventional MSRs from nonbank mortgage firms. JPM ranks #2 after Wells Fargo & Co (WFC) in owned mortgage servicing at just below $900 billion in unpaid principal balance (UPB) of loans. Most of the top-ten owners of MSRs are nonbanks, but Bank of America (BAC) is #9 at $300 billion in UPB. The table below shows the results for JPM and the impact of First Republic Bank broken out.

Of particular note, JPM took $900 million in losses on investment securities in Q2 2023 as the bank continues to aggressively clean house of COVID era exposures. This expense was easily offset by the accounting gains from the purchase of First Republic Bank. We expect to see continued strong performance from JPM, but we do expect them to focus on shrinking the bank balance sheet as the Fed continues to roll off ~ $75 billion per month in reserves and even more cash from roll-off of Reverse Repurchase Agreements.

One reason that JPM and other large banks will be looking to reduce assets is because regulators are preparing to impose new capital requirements and other levies on large banks. In this regard, JPM provided three key points of guidance for 2023: 1) Expect FY2023 net interest income excluding markets segment of ~$87B, market dependent; 2) Expect FY2023 adjusted expense of ~$84.5B excluding the FDIC special assessment; and 3) Expect FY2023 Card Services NCO rate of ~2.60

Point 2 reflects the fact that the FDIC is preparing a special assessment to replenish the bank insurance fund that will be paid entirely by the largest banks. This assessment seeks to cover the $15 billion cost of covering the uninsured depositors of Silicon Valley Bank and Signature Bank will be a significant financial expense for JPM and other large banks.

Perhaps the most improved of the large banks Friday was WFC, which saw total revenue up $3.5 billion vs Q2 2022. ROE rose to double digits for the second quarter in a row and operating expenses fell. WFC took twelve points out of its efficiency ratio, pushing this key indicator down to 61. Efficiency is one of the key criteria we identified previously as needing improvement for the bank to be attractive to investors. Note that JPM's overhead ratio was 49 in Q1 2023.

WFC’s deposit base fell 7% in Q2 2023 and we expect to see more shrinkage as the year progresses. Interest expense rose 27% in Q2 2023, the most of any large bank so far this quarter. Mortgage banking revenue fell 13% as WFC continues to withdraw from correspondent loan purchases and related commercial lending. Just the end of third-party mortgage purchases could see the bank shrink assets and commercial deposits significantly during the rest of the year.

WFC managed to boost net income nicely in Q2 2023, but the driver was noninterest revenue. NIM for WFC actually fell in Q2 and the outlook is for the bank to continue shrinking the balance sheet and running off the $900 billion UPB mortgage servicing book. Indeed, if we include First Republic's $100 billion in MSR, JPM is officially even with WFC now. We think that bulk sales of MSRs could make JPM the largest bank owner of residential servicing assets by next year. (Note: Of course, as a reader notes, there is $250 billion in UPB of originated mortgage loans inside JPM already, but WFC also has a huge internally originated loan book where the MSR is never capitalized.)

Bottom line: JPM has an impressive lead in earnings and growth over WFC and C, neither one of which is positioned to catch up with Jamie Dimon in 2023. As Jim Cramer noted on CNBC last week: "JPM is a growth stock." We look for better results from USB, but the jury is still out until July 19th. Bank of America (BAC), on the other hand, is one of our bigger concerns because of the mediocre performance in Q1 2023 in terms of funding costs and net losses.

Disclosure (07/15/23)

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