Trepp LLC

04/20/2021 | News release | Distributed by Public on 04/20/2021 08:23

Q1 2021 Bank Earnings: Tastes Great, Less Filling

Earnings from the largest banks surged in the first quarter. There is certainly much to cheer, with revenues up and loss provisions down (negative, actually). And the prospects for future growth should be good as the economy gets on firmer footing in general and the steepening of the yield curve during the first quarter bodes well for an improvement in net interest margins.

While the surge in earnings 'tastes great,' it is less satisfying, as it has been driven by the huge swing in the banks' loss provisioning, rather than robust revenue growth. Market reaction to the banks' earnings announcements has been somewhat negative on balance. Share prices for the four banks as a group rose by 1.1% for the week (April 9th to 16th), but that was driven by an 8.2% gain for Wells Fargo. Share prices for the other three banks fell by -1.3% for the week. Investors will be looking for revenue growth - rather than reduced loan losses - to drive higher earnings.

  • Aggregate earnings for the four banks surged by 249% from the first quarter of 2020. The increases for each of the banks were very strong, ranging from 100% (Bank of America) to 635% (Wells Fargo).
  • Total revenues for the four banks increased by 3.3% from Q1 2020.
    • Net interest income fell by -14.8% from Q1 2020. While the yield curve has steepened during the first quarter, weak new loan production has caused banks' net interest margins to slide to new lows. More on that below.
    • Noninterest income jumped by an aggregate of 25.7% from Q1 2020. Fee revenue - including investment banking fees and trading revenues - was up. The absence of securities writedowns, which had been taken in early 2020 when the pandemic hit, also contributed to noninterest income growth.
  • Loss provisions swung further into negative territory, as the banks continued to dial back on their credit loss expectations. The reversal in provisioning for loan losses was the main driver behind banks' increased earnings in Q1 and represents a relatively optimistic view of future charge-offs related to the pandemic. More on loss provisions and reserves below.
  • Non-interest expense jumped by 9.9% from Q1 2020, as the banks experienced higher Covid-related expenses, increased compensation expenses, and costs of generating revenue. The jump in expenses is more noticeable, as the banks had kept a tight rein on expenses through 2020.

Loss Provisions - Dialing Back

Loss provisioning shifted further negative in the first quarter, as all four of the large banks reversed earlier loss allowances. The aggregate loss provision for the four banks was -$9.1 billion, creating a $33.1 billion difference from the $24.0 billion loss provision in the first quarter of 2020. This constitutes a positive contribution to the change in earnings over the same period, which is greater than the actual $25.1 billion change in aggregate net income. In other words, the surge in net income compared to the first quarter of 2020 is more than accounted for by the reductions in loss provisioning.

The recent reversal in loss provisioning follows a two-quarter surge during Q1 and Q2 2020 and a return to 'normal' during Q3. This can clearly be seen as a recalibration of the banks' loss estimates stemming from the pandemic-induced surge in unemployment and economic volatility. Although the Covid-related disruption to the economy is not yet over, the recalibration of loss expectations is a clear signal that the banks think their current loss reserves should be sufficient to handle future charge-offs of bad loans.

Net Interest Margins - Bottoming Out… Probably

Interest margins fell for the eighth consecutive quarter in Q1 2021, extending a protracted slide that started in early 2019. Net interest margins are now at their lowest level since the Great Recession. Lower interest margins have translated into weaker revenue growth for banks since the net interest income is a function of interest margins and loan origination volume. Net loan growth overall was barely positive in Q1, with contraction in both C&I and residential real estate lending largely offsetting gains in consumer lending. Commercial real estate was flat, with a decline in multifamily residential lending offsetting increases in construction and commercial mortgage lending.

  • The yield curve has steepened recently, with 10-year T-bond yields nearly reaching 1.75% at the end of March 2021. If long-term rates rise further, that could help reverse the slide in net interest margins and support revenue growth.
  • Loan growth will also be a necessary component of future improvement in net interest margins. Despite recent gains in consumer lending, the contraction in C&I and residential lending has undercut banks' ability to expand their loan book, which provides origination fees on new loans and a greater asset base on which to earn interest.
  • The largest banks derive around 50-60% of their revenues from net interest income. Smaller banks derive a significantly higher share of their revenues from net interest income, so the continued weakness in interest margins will weigh more heavily on smaller banks.

Looking Ahead - Near-term Volatility

Year-on-year comparisons will likely remain volatile for the next several quarters. The distortions created in 2020 by the pandemic's impacts will continue to be felt for some time. Bank earnings in Q2 2020 were depressed by the peak loss provisioning that occurred in the earlier stages of the pandemic-induced economic downturn. So Q2 2021 earnings growth for banks will appear strong when compared to Q2 2020.

Also, further shifts in loss provisioning in the months ahead will probably add to the volatility of earnings. During the last two quarters, the large banks have unwound $11 billion of the $57 billion that they added to loss reserves in the first half of 2020. Robust economic growth could cause the banks to dial back further on their pandemic-driven loss estimates, which would give another temporary boost to earnings.

Ultimately, the banks will want to return to a 'more filling' source for earnings, namely increased loan growth and higher interest margins. That should be achievable, but with the protracted slide in net interest margins over the last two years and still-tepid loan demand, it may be some time before bank earnings return to normal.

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The information provided is based on information generally available to the public from sources believed to be reliable.