Deep Dive: Big U.S. banks’ day of reckoning is delayed

But most of the stocks have declined since earnings season began. Below are tables comparing actual results to analysts’ estimates and to previous quarters.

Loan losses rise only slightly

The largest banks made outsized provisions for credit losses (the amount added to loan loss reserves, which directly lowers pre-tax earnings) during the first and second quarters, to prepare for an expected wave of loan defaults. This is normal activity in any recession.

So two quarters of earnings were depressed or wiped out for many banks that focus on lending, as opposed to trust and custody or investment banks. That changed during the third quarter, with much lower provisions.

Capital One Financial Corp. COF, +1.61% released $742 million in loan loss reserves during the third quarter — that is, the bank’s net loan charge-offs exceeded its provisions for reserves by that much, boosting earnings. Its loan losses during the third quarter were down tremendously from the second quarter of 2020 and even from the year-earlier quarter.

During a recession and recovery cycle, sequential comparisons of banks’ results can be more important than the usual year-over-year comparisons, not only because of loan defaults and losses but because of the rapid decline in interest rates. For the largest banks, third-quarter provisions were down significantly from the second quarter.

Here are the 10 largest U.S. banks by total assets, with third-quarter provisions for loan losses compared with consensus estimates among analysts polled by FactSet from our Oct. 8 earnings preview, along with actual figures for the previous quarter and the third quarter of 2019.

All dollar figures in the following tables are in millions, except for total assets, which are in billions. Scroll the table to see all the data.

Click on the tickers for more about each bank holding company, including news coverage, analysts’ ratings and price targets.

“The jury is still out” on how severely the pandemic credit crisis will be for loan portfolios, according to Pri de Silva, a senior corporate bond analyst at Aware Asset Management in New York. During an interview, de Silva said credit losses tend to peak at the end of a recession.

“That trend should hold steady this time. If you look at the COVID-19 recession, three quarters in, losses are still in line with 2019.”

Net charge-offs are loan balances written off and charged against reserves, less any recoveries. Here are those totals from the third quarter, compared with the second quarter of 2020 and the third quarter of 2019:

For most of the big banks listed here, net charge-offs declined sequentially during the third quarter. Here’s another look at charge-off activity relative to average loans:

Net charge-off ratios aren’t yet available for all the banks because average loans won’t be available until their full 10-Q reports are filed. But you can see small sequential and year-over-year increases in net charge-off rates, which are still at historically low levels for any economy. Capital One Financial’s charge-off rates are higher than the others because of its concentration in credit-card loans, which made up 42% of the bank’s total loans held for investment as of Sept. 30. That also explains Capital One’s much higher net interest margin, below.

During J.P. Morgan Chase’s JPM, +0.90%  third-quarter earnings call, CEO Jamie Dimon said that under his team’s “base case” economic projections, the bank was “probably something like $10 billion over-reserved.” Dimon also cautioned that it was “hard to predict” the direction and timing of a continuing economic recovery and said the bank was “prepared for a relatively adverse case.”

Being over-reserved by $10 billion points to an eventually release of reserves that would pad earnings and support good comparisons several quarters out. When asked about $10 billion in potential reserve releases, de Silva said “it is possible.”

JPM, Citigroup C,  and Bank of America BAC, +0.12%  “have reserved the most because they are the biggest credit card issuers. Any time realized losses come in better than expected, those are the ones that are going to outperform,” de Silva said.

Dan Eye, head of asset allocation and equity research at Fort Pitt Capital Group in Pittsburgh, said JPM is his favorite stock in the space right now, because of its “fortress balance sheet, great management team and great capital position.”

But Mark Doctoroff, the global co-head of MUFG’s Financial Institutions Group, said it’s too early to expect a rosy credit cycle. The effect of the federal government’s stimulus programs to help consumers and businesses, along with loan forbearances for mortgage borrowers and delays of evictions for renters who are unable to pay, has been “kind of kicking the can.”

“Going forward, stimulus talks continue and there is a lot of damage to the economy. In New York City, there are for-rent or lease signs everywhere,” he added during an interview. He expects to have a better indication of whether or not banks will see actual damage to their balance sheets from loan losses in the first quarter of 2022.

Declining interest income

With the Federal Reserve lowering the target for the short-term federal-funds rate to a range of zero to 0.25% and pushing down long-term interest rates by buying bonds, the yield curve has flattened, making it more difficult for banks to earn their usual spread income.

Net interest income was down for most of the big banks not only because of narrower spreads but because of declining lending activity. During the third quarter, mortgage lending volume declined from the second quarter, when there was a spike in refinancing activity because of the sharp decline in interest rates, according to Eye.

A bank’s net interest margin is its interest income, less interest on deposits and borrowings, divided by average total assets.

Net interest margins have narrowed for most of the big banks:

There’s always hope from the banks that the yield curve will steepen.

“We can still see rates move on the longer end of the curve,” Eye said. “What would drive that would be better economic data and some inflation in the system as well.”

Those might lead to a curtailment of bond purchases by the Federal Reserve. It is also possible that a continuing $3 trillion federal budget deficit will flood the market with enough new bonds to push long-term interest rates higher.

Fee income

“You see the earnings power of banks like J.P. Morgan Chase — it is pretty impressive. But the driving factor in overperformance has been trading revenue and investment-banking fees, which are volatile,” Doctoroff said.

Here’s non-interest income for the third quarter compared with consensus estimates among analysts polled by FactSet from our Oct. 8 earnings preview, along with actual figures for the second quarter of 2020 and the third quarter of 2019:

EPS

Most of the 10 largest U.S. banks beat third-quarter consensus earnings-per-share estimates:

So 2020, so far, can only be called a good year for the banks — the group looked ahead during the first and second quarters and set aside a lot of money to weather the expected loan loss storm, which was delayed by unprecedented government and central-bank stimulus.

But “you can’t keep the patient on life support forever,” Doctoroff said, pointing to a possible spike in loan losses during the fourth quarter and first quarter of 2021. There’s no way of knowing how long this credit cycle may last because of all the uncertainty about containing the coronavirus.

Once there is a clear light at the end of the tunnel, reserve releases and a steepening yield curve may set up a long period of rising earnings for the banks. Eye said Fort Pitt Capital Group has “a slight overweight with the financials, so the rebound play is in line with our view.”