Earnings season has come and gone for America’s biggest banks, and if it has taught us anything, it’s this: If you’re a bank, it’s best not to look like one. Third-quarter earnings from the big banks—a cohort that includes JPMorgan Chase (ticker: JPM), Citigroup (C), and Bank of America (BAC)—largely surprised to the upside as robust trading activity helped offset lower net-income margins, and profits weren’t crimped by having to add billions to reserves to protect against bad loans.
You wouldn’t know it by looking at their stocks, however. JPMorgan shares fell by more than 2% after reporting, despite beating earnings per share expectations by 31%; Citigroup dropped 4.8% despite a 54% beat; and Bank of America lost more than 5% after topping forecasts by 4%. Even balance sheets that have been tested for just about any outcome don’t seem to be enough. For investors in the big banks, the glass seems to always come up half empty.
The situation is largely out of the banks’ control. They’re dependent on interest income, but rates are near zero and the Federal Reserve is likely to keep them there for the next couple of years. It has been painful: Bank of America saw a 17% drop in net interest income, surprising analysts and casting doubt on future loan growth even as management said it thinks interest income bottomed in the third quarter. Wells Fargo (WFC), in particular, faces a tougher path ahead as its net interest income fell by 19.6%, a result of operating under a $2 trillion asset cap imposed after its fake-accounts scandal.
The banks can try to make up for that with loan growth, but even that’s fraught with the economic outlook so uncertain. Banks have set aside billions for bad loans in case economic forecasts that are more dire than consensus views—cash that could be released if the situation improves.
The risks, though, remain high. JPMorgan CEO Jamie Dimon said his bank is probably $10 billion over-reserved. The eventual release of those reserves could be a boon to shareholders, but if conditions dramatically worsen, the bank could be $20 billion under-reserved. It’s a bet investors don’t seem willing to make.
It’s a shame, given that everything else seems to be going right for JPMorgan these days. The bank, with its mix of investment-banking and consumer-banking services, saw its profits rise 4% compared to last year’s third quarter, thanks to a 30% jump in trading that offset a 9% drop in net interest income. Unfortunately, it’s still a bank.
But relying on trading isn’t a winning formula either, despite double-digit growth at most of the big banks. Trading had actually been a declining business for banks in the years since the financial crisis, and investors are doubtful that recent boffo trading figures can last. For instance, Goldman Sachs Group (GS) reported record earnings thanks to 29% growth in its trading business, which accounted for 42% of the bank’s revenue. But even Goldman is in the midst of a multiyear effort to diversify its revenue by moving into consumer banking. Apparently, it wants to look more like JPMorgan.
One bank that has largely been immune from scorn this year is Morgan Stanley (MS). Shares are roughly flat in 2020, while the rest of the sector is off by 30%. It was also one of the few banks to see its shares rise after reporting its results—its stock rose 1.3% this past Thursday.
Like Goldman, Morgan Stanley benefited from a surge in trading activity, but it’s wealth and investment management units, which grew by 7% in the third quarter, have been providing the kind of stable returns investors want to see. “The market is looking to reward [banks with] longer lasting, predictable revenue streams,” David Konrad, managing director at D.A. Davidson, tells Barron’s.
And Morgan Stanley is continuing to move in that direction. It recently completed the acquisition of E*Trade, and is buying money manager Eaton Vance (EV), using cash that the Federal Reserve has said it can’t return to shareholders.
“We have to do something with this capital,” Morgan Stanley Chairman and CEO James Gorman told analysts. “Our shareholders, rightfully, who own the company, are entitled to generate a decent return on the capital investment in the company.”
And Morgan Stanley may have found the formula to give it to them.