U.S. banks are on the verge disclosing how they concluded 2014, which was quite troublesome for the industry as a whole from the start. The quarter was no better in terms of volatility in the financial markets and rising structural pressure. Further, there were downsides like soft trading volumes, lackluster client activities and high legal costs to the tune of what was witnessed in the first three quarters.
Moreover, demand for fresh mortgages remained depressed with feeble mortgage activity due to continued uncertainty over interest rates. The rate uncertainty also paired up with stringent regulatory requirements to keep demand for fixed-income securities muted. Though the last voice from the Federal Reserve signaled a rate hike some time in 2015, sharply lower oil prices and a strengthening dollar added to the uncertainty.
Apart from making a rate increase uncertain, the oil price slump is also raising fresh concerns for lenders exposed to energy firms fraught with severe credit issues. The impact of weak energy lending could be prominent in the Q4 results of the concerned banks.
Growth in advisory and underwriting revenues, which were one of the major driving forces in the first three quarters on the back of an M&A boom, is likely to lose strength in Q4. It’s not that M&A activity slowed during the quarter, but underwriting of U.S. banks remained somewhat dormant.
On the optimistic side were the superior performance by asset management business, a still high investment banking transaction backlog and continued cost containment through reorganization.
The overall backdrop looks a bit gloomy compared to what the industry witnessed at least in the second and third quarters. However, it all depends on the extent to which the strategic actions taken by banks were able to evade the pressure.
While there is no such tangible reason to drive outstanding results, we don’t expect too many banks missing earnings estimates either. This is because the concerns surrounding the industry have led to downward estimate revisions by the analysts. While a number of banks might have struggled to earn better than the year-ago quarter, their underlying strength should at least be sufficient to make them beat the conservative estimates.
The broader Finance sector, of which U.S. banks are part, is expected to witness an almost flat year-over-year earnings in the quarter. However, that compares unfavorably with a 3.8% increase last quarter.
Looking at the 6 medium-level (or M-level) industries in the sector, it appears that Major Banks suffered the most during the quarter with an expected 14.2% year-over-year earnings decline. Banks & Thrifts seem to have performed relatively better, but are expected to witness a 10.2% earnings decline.
(For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)
Likely Affecting Factors
While the currency trading desks should do better on the back of improved foreign exchange rates during the quarter, the overall performance of FICC (fixed income, currencies & commodities) trading units remained lukewarm.
Mortgage banking activities witnessed an improvement, albeit marginal, for the second consecutive quarter in Q3 after four straight quarters of decline. But these activities were again tepid in Q4 due to depressed demand for fresh mortgages and lesser avenues for new originations.
While M&A activity remained strong during the quarter, investment banks missed the boat. Underwriting activities were weak enough to drag the overall investment banking revenues.
High legal and restructuring costs, dearth of significant loan growth and pressure on net interest margins were the other nagging issues. Weak energy lending due to the oil price disaster was also a serious headwind.
Likely Supporting Factors
The investment banking transaction backlog is likely to support fee generation, partially offsetting the impact of weak underwriting activities.
Aggressive cost control through streamlined operations and job cuts should keep contributing to the bottom line.
Further, a favorable asset market backdrop and encouraging macroeconomic factors are likely to have lent some support to the financials.
How Are Forerunners Expected to Perform?
Based on our proven model, we are not confident about earnings beats for most of the industry leaders. According to the Zacks methodology, a stock needs to have both a positive Earnings ESP and a Zacks Rank #3 (Hold) or better for an earnings surprise call.
Earnings ESP is our proprietary methodology for identifying stocks that have the best chances to surprise with their upcoming earnings announcements. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.
Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.
Here are the expected numbers from four major banks reporting this week:
JPMorgan Chase & Co. (JPM)
This Zacks Rank #3 banking giant is scheduled to kick-off the Q4 banking earnings season before the opening bell on Jan 14.
- Zacks Consensus Estimate (earnings per share): $1.32 (versus $1.40 reported in Q4 2013)
- Zacks Consensus Estimate (revenues): $23.9 billion (versus $23.7 billion reported in Q4 2013)
- Earnings ESP: -1.52%
We cannot conclusively say that JPMorgan will beat the Zacks Consensus Estimate. Though the company’s Zacks Rank #3 increases the predictive power of ESP, we also need to have a positive ESP to be confident of an earnings surprise call.
Wells Fargo & Company (WFC)
This Zacks Rank #3 company will also release Q4 results with JPMorgan on Jan 14, before the opening bell.
- Zacks Consensus Estimate (earnings per share): $1.02 (versus $1.00 in Q4 2013)
- Zacks Consensus Estimate (revenue): $21.2 billion (versus $20.5 billion in Q4 2013)
- Earnings ESP: -1.96%
Wells Fargo also doesn’t have a right combination of Zacks Rank and Earnings ESP. So we cannot be conclusive about an earnings beat for this company either.
Citigroup Inc. (C)
Again, this is a Zacks Rank #3 company which is scheduled to release its Q4 earnings before the opening bell on Jan 15.
- Zacks Consensus Estimate (earnings per share): 13 cents (versus 76 cents in Q4 2013)
- Zacks Consensus Estimate (revenues): $19 billion (versus $18.2 billion in Q4 2013)
- Earnings ESP: -23.08%
Here, too, the combination of Zacks Rank and Earnings ESP doesn’t conclusively show that Citigroup will beat the Zacks Consensus Estimate.
Bank of America Corp. (BAC)
This Zacks Rank #3 company is scheduled to release its Q4 results before the opening bell on Jan 15.
- Zacks Consensus Estimate (earnings per share): 32 cents (versus 29 cents earnings in Q4 2013)
- Zacks Consensus Estimate (revenues): $21.2 billion (versus $21.2 billion reported in Q4 2013)
- Earnings ESP: -3.13%
We are not confident of an earnings beat for Bank of America either, as it does not have the right combination of Zacks Rank and Earnings ESP.
Bottom Line
While the releases on Jan 14 will signal how the quarter was for the industry, the expectations for all four giants show a disappointing picture. So, it is advisable for investors with a strong preference for banking stocks to wait until the releases of forerunners. If the results are encouraging, one could bet on those with a favorable combination of Zacks Rank and Earnings ESP.
However, investors with a strong risk appetite could go for stocks with such a combination even before the banking earnings kick off. If the reality depicts something else – a favorable performance – with hidden strengths working in favor, an early investment would be rewarding.
Keep an eye on our earnings preview and earnings report coverage in the coming days on www.zacks.com home page.
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