The Sustainability of Big Bank Earnings
Investment banking and declining delinquencies helped power strong results for J.P. Morgan and B of A, but uncertainty in the housing market and broader economy still loom, says Morningstar's Jaime Peters.
The Sustainability of Big Bank Earnings
Jeremy Glaser: I'm Jeremy Glaser with Morningstar.com with J.P. Morgan and
Bank of America kicking off big bank earnings this week.
I'm here with senior bank analyst Jamie Peters to talk about the
results and to see what the future might hold for these companies.
Jamie, thank you for joining me today.
Jamie Peters: Good morning.
Jeremy Glaser: One of the things that struck me about these earnings releases is
that the investment bank results really seem to be driving earnings.
Is this something that you've seen over the past couple quarters or
something that you think is sustainable over the long run?
Jamie Peters: Well, investment banking results last year were actually quite
exceptionally high because of widespread and favorable conditions
in the fixed-income market. We had expected them to start to come
back down, but what is happening is that there is such activity in
fixed-income right now that the banks are still posting very, very
First quarter is always a seasonably high quarter, so as a result we
do expect returns to come down over the year, but they're still
performing much better than we expected.
Jeremy Glaser: Do you think this is something that investment banks can keep
doing well over time or do you think there will be a reversion back
to the mean where this kind of out performance is going to
Jamie Peters: In part, well disappear as the fixed-income market starts to settle
down a little bit more. Credit spreads have already come in quite a
It's simply the level of activity right now that is so high. As that
starts to calm down a little bit as well and we don't have places like
Greece having crises, then we will see revenues come down as
Jeremy Glaser: Moving to the other side of the business, what's happening with
charge-off rates and with delinquency rates on the loans made to
consumers and businesses?
Jamie Peters: It's an interesting story. We're having J.P. Morgan, Bank of
America actually showing fairly decent numbers in early
delinquency buckets. That means that new people aren't getting
behind on their loans quite as much.
However, we saw a different story as far as charge-offs. They're
really still quite high compared to historical levels. They're going
to remain high. We saw J.P. Morgan's should come down a little
bit. We saw Bank of America's go up a little bit. That was mainly a
result of them changing how they recognize charge-offs, though.
The reality is that things are really starting to stabilize. Now that
could be temporary and the two companies took very different
attitudes towards it. Bank of America seemed to be pretty happy
and thinking that things are probably going to continue to get
better, whereas J.P. Morgan was a little bit more cautious. They
were suggesting that the improvements in the housing market
simply could simply be transient that we have a lot of things
We have an $8,000.00 homebuyer's credit. We have interest rates
at a current year low that could start increasing. Any of these
things could destabilize the housing market. We could start seeing
home prices fall again. And as a result, we'd see loan loses go up
Both companies are going to be fairly damaged if their earnings
are going to keep hurting if that happened. So they're in a different
sort of attitude. Bank of America a little more aggressive, J.P.
Morgan a little more conservative but that's because J.P. Morgan
can afford to be a little more conservative. It winds up being a
fairly good story right now, but it's one that could change on a
Jeremy Glaser: Over the last two years, we've seen the banks contract their
lending. Do you think that's a function of that there just isn't
demand out there for loans right now or do you think that the
banks are really trying to shrink their books?
Jamie Peters: It's actually a combination of both. What's going on is that
customers who are not credit-worthy, who probably should not
have gotten a loan in the first place when we had the big bubble
run-up are not finding loans. But customers who are credit worthy
are finding loans right now.
What's happening is that, especially on the commercial side where
you've seen the most contraction, businesses are not hiring, they
are not building inventory. And as a result, they do not need new
loans, so you're seeing the books come down a little bit.
Banks are kind of iffy on what's going to happen, when it's going
to turn. They're hoping by the end of the year especially if the
economy continues to recover that we might see stabilization in
unemployment, and potentially see new hiring as well as inventory
builds which would help them reverse that trend on their loan
Jeremy Glaser: Financial regulatory reform is another big topic on a lot of people's
minds if they're invested in these banks. How are they dealing with
the uncertainty that they're not sure what any legislation would
eventually look like?
Jamie Peters: You know it's very interesting. Some of them are very reluctant to
comment on it especially individual portions of it because we're
not sure where it's going to fall out. As a result of that uncertainty,
what they are doing is they're being conservative on the capital
Bank of America, J.P. Morgan, they earned quite a bit more than
their penny and nickel quarterly dividends. But they are not going
to raise those dividends until they have a good sense from the
government what's going to happen with all those three. What are
the regulations going to be? Where are the minimum capital levels
going to be?
Until we find out those types of answers, we're going to expect that
these companies are going to retain their earnings because the last
things they want to do is start raising their dividends, paying out
the capital, and then discover six months to 12 months down the
line that they're going to fall short and they're going to have to
raise capital. It's cheaper to retain than to pay out and then try to
get it back.
Jeremy Glaser: So what do you think about the valuation levels of these stocks
Jamie Peters: Both companies are actually slightly undervalued. They're not
exceptionally undervalued. We aren't in last March where they
were trading for pennies on the dollar of what they're worth in the
What we do have right now is a slight discount to our current fair
values. That might continue to go on or it might start closing the
gap if people start getting a little more confident in the recovery of
the economy. But people are still going to be cautious and there are
still quite a wide variety of options that could happen to these
banks earnings because we do not know if the housing market is
going to stay stable. We do not know if unemployment is going to
start to improve. As a result, what could happen by the fourth
quarter of this year, the range could be up 100% or could be down
Jeremy Glaser: All right. Jamie thanks so much for talking to me today.
Jamie Peters: Thank you.
Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser.
The Sustainability of Big Bank Earnings
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