Big U.S. bank earnings off to a shaky start

Mediocre JPMorgan and Citigroup earnings once again lay bare how dependent big U.S. bank shares are on tax cut hype

Tax cut hype vs. earnings

JPMorgan and Citigroup earnings again lay bare the hype over potential U.S. tax cuts. Neither ‘bulge-bracket’ behemoth knocked the ball out of the park on Thursday, with little sign of significant improvement in earnings momentum ahead. We think this calls the financial sector’s surge from the doldrums this year into question. We’re turning more cautious on the largest banks and many lenders are indeed dropping hints that the current quarter could also be soft.

That’s despite both JPM and Citi staging upside surprises and Citigroup even setting the bar for trading revenues in a quarter that was expected to be a fallow one due to a lack of volatility. Even at Citi though, the overall trading take was 11% lower than Q3 a year ago, with a 16% rise in equity transactions to $757m failing to offset a decline in fixed income. Furthermore, Citi’s quarter was also flattered by a $580m pre-tax gain on the sale of an analytics business. With that stripped out, Citi’s $1.29 EPS was below Wall St. forecasts calling for $1.32. A drop in expenses helped contain the hit at Citi, buttressing an emerging defensive quality in the bank’s shares. CEO Michael Corbat’s long-term project to reduce expenses to be amongst the lowest on Wall St continues apace. Such efforts left return on common equity at 8.4% in the quarter.

Citigroup ROE bucks trend

That’s still a far cry from JPMorgan’s ROE improvement, which was up at 11% in Q3, though that declined from the second quarter, adding to pinch points that included a 27% dive in bond trading and a 4% slip in equity markets. It was further traction in JPM’s push for dominance in the fastest-growing credit segments like autos and cards that saved its results from a worse showing. The largest U.S. bank by assets saw loan growth rise a solid 7%, with a further of 10% tailwind from net interest income. The extent to which the group is pinning its hopes on loan growth is shown maintained guidance overall but loan growth expected to tick higher to 8% in Q4. Either way, Q3 loan growth wasn’t enough to offset the 21% tumble in markets revenue, which was slightly worse than guidance. And whilst credit might be one of the few games in town for banks right now, we expect investors to begin weighing how comfortable they are with JPM’s determination to increase exposure. The risk that loan losses could trend higher across the sector was underscored by Citi on Thursday. It sees net credit losses for branded cards in the U.S. rising to 2.95% next year and the loss rate building “somewhat” earlier than initially expected. It was referring to its own business but the view should be cautionary about the sector too. Investor reckoning about worsening credit conditions will come on top of a wary view of major U.S. lenders having crept above-book-value of late.

4 to go

Assuming the Trump administration’s push for corporate tax cuts bears fruit—presumably no sooner than late 2018—a lot would be smoothed off the outlook for the bulge bracket. We therefore expect the fourth quarter to see strain return to shares of the Big 6. The picture will be clearer after Wells Fargo, Bank of America, Morgan Stanley and Goldman report quarterly results in coming days.

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