Financials got off to a strong start in 2014, but after yesterday’s decline and today’s tepid bounce, XLF is actually negative now for 2014. Earnings season for the sector kicked off today with JPM and WFC both reporting earnings.
JPM has been higher for most of the morning, while WFC has been lower, but I actually consider JPM’s report weaker, and WFC’s report stronger.
First, let’s start with the good news:
–Both companies beat the headline earnings number on adjusted EPS. WFC had the cleaner beat, as JPM’s number included a number of one-time adjustments. The main positive for JPM is that its legal costs going forward are likely to be lower after many of its settlements in 2013.
–Both companies reported increased loan demand among commercial customers. Managements were also more optimistic on the conference calls for potential loan growth among corporates in 2014, especially if economic growth picks up like they expect.
And the bad news:
–Both companies missed on the revenue expectation by 3-6%. That’s crucial because the potential for future loan loss reserve releases and other accounting moves to boost earnings in 2014 is much more limited relative to the past few years. Without revenue growth in 2014, both banks will struggle to grow earnings.
–The mortgage business has not recovered after the spike higher in rates in mid-2013. Non-interest income in the consumer banking business was significantly lower for both WFC and JPM as a result of the decline in mortgage originations, partially offset by lower non-interest expense as the banks cut expenses against the revenue decline.
–For JPM, investment banking revenues were weak. Despite the IPO boom in the fourth quarter helping equity capital markets, the overall investment bank missed expectations. Given that the overall environment was favorable (rising asset prices, strong deal flow), that’s worrying for 2014 if macro trends turn.
As for potential trade considerations given what we’ve seen so far:
Here is what I wrote about JPM’s earnings this morning in our BAC preview:
Most of JPM’s businesses saw year-over-year declines in net revenue, but increased income due to reduced credit losses, lower expenses or higher asset prices.
Based on JPM’s numbers, the overall business climate for the large, consolidated banks is not great heading into 2014. The mortgage and investment banking businesses are flat at best, while the commercial and retail banks are better, but not by much.
While both companies missed on revenues due to the mortgage decline, I am more concerned about JPM than WFC given the significance of investment banking for JPM. Since analysts have modeled in 5% earnings growth for JPM in 2014 (vs. only 3% for WFC), and the potential for more loan loss reserve releases is limited, JPM could have a harder time meeting expectations in the new year.
Implied volatility in JPM is at a 2 year low after the earnings report, which could be an opportunity for a trade:
[caption id="attachment_34761" align="alignnone" width="600"]
JPM 30 day implied vol, Courtesy of Bloomberg[/caption]
We’re looking at potential trade ideas, but wanted to get our broad thoughts out first.