Inside Bank Earnings

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DOW – 118 = 20,404
SPX – 4 = 2338
NAS + 13 = 5863
RUT + 5 = 1367
10 Y + .02 = 2.20%
OIL – 1.83 = 50.58
GOLD – 8.90 = 1281.30

Energy stocks were under pressure Wednesday as crude-oil prices settled at a two-and-a-half week low and its biggest one-day loss in 6 weeks. Gasoline inventories posted a surprise increase, a counter-seasonal build of 1.5 million barrels in the latest week, along with an increase in U.S. production. The energy sector was the worst performer among the S&P 500 index’s 11 sectors.

Shares of International Business Machines were largely responsible for a decline in the Dow industrials. IBM lost about 5%, after posting its 20^th consecutive quarter of declining revenue. IBM has an outsize impact because the Dow is price-weighted, meaning the most expensive stocks (rather than the largest companies) have the biggest pull.

Monday’s rally was on low volume, a sign of weakness. Tuesday’s selloff saw volume increase. In the U.S. Treasury market, bond yields rose after a rally on Tuesday sent yields to five-month lows.

The Federal Reserve publishes the Beige Book two weeks prior to FOMC monetary policy meetings. The Beige Book gathers anecdotal reports from the 12 Fed districts; not hard economic data, rather observations and remarks.

Wednesday’s Beige Book found “a larger number of firms mentioned high turnover rates and more difficulty retaining workers.” Tight labor markets are broadening out wage gains but price pressures remain modest. A couple of districts said that worker shortages and increased labor costs were restraining growth in manufacturing, transportation and construction but overall inflation was modest, the report said.

Selling prices rose only slightly.  The information suggested somewhat softer readings in non-auto consumer spending and an expansion in the manufacturing sector. Home building accelerated and energy-related businesses reported “improved conditions.” Uncertainty about tax-and-spending policies was one factor mentioned in several districts as a restraint on activity.

Federal Reserve Vice Chairman Stanley Fischer yesterday said there’s been a “benign” foreign market reaction to the central bank’s two rate hikes in four months. Fischer said: “The main reason for the positive market reaction is that foreign output expansions appear more entrenched, and downside risks to those economies noticeably smaller than in recent years.” He pointed out that European unemployment has fallen and China’s economy also is on a more solid footing.

He says there’s a chance foreign economies kick into gear enough that U.S. and foreign business conditions become aligned, as they did during the tightening cycles that began in 1999 and 2004. “A gradual and ongoing removal of accommodation seems likely both to maximize the prospects of a continued expansion in the U.S. economy and to mitigate the risk of undesirable spillovers abroad.”

Boston Fed President Eric Rosengren says the Fed should start shrinking its balance sheet relatively soon but do it so slowly that it doesn’t disturb the central bank’s plans to continue to gradually raise short-term interest rates. The Fed amassed $4.5 trillion in Treasury and mortgage-related assets in the wake of the financial crisis to push down long-term rates. Officials believe the balance sheet is still boosting economic conditions.

With the economy on more solid footing, the central bank wants to allow the balance sheet to shrink to a more neutral size. Rosengren suggested the Fed should initially retire a small percentage of maturing securities and then very gradually shrink the volume of the securities being reinvested. This confirms that asset purchases are now part of the Fed’s playbook and may be used again in the future; and that this Fed believes in gradualism; no sudden movements to spook the markets.

Earnings season rolls on.

eBay (EBAY) net income rose to $1.04 billion, or 94 cents per share in the first quarter, from $482 million, or 41 cents per share, a year earlier, but they lowered guidance, forecasting current-quarter profit largely below expectations, sending its shares down as much as 4.5 percent in extended trading.

Ebay said it expects current-quarter adjusted profit of 43-45 cents per share. Analysts on average were expecting 47 cents per share. EBay has been facing relentless competition from much larger rival Amazon. To lure more shoppers and better compete with Amazon as well as traditional retailers, the company has made several changes to its platform.

Qualcomm (QCOM), the largest maker of chips used in smartphones, reported 9.6 percent fall in quarterly revenue, hurt by an arbitration decision to pay Canada’s BlackBerry for previously received royalties. Net income attributable to the company fell to $749 million, or 50 cents per share, in the second quarter ended March 26, from $1.16 billion, or 78 cents per share, a year earlier.

No. 3 U.S. railroad CSX Corp (CSX) reported a better-than-expected quarterly net profit driven by rising freight volumes across most of the markets it covers and said it plans to cut costs and boost profitability moving forward. CSX posted first-quarter net profit of $362 million or 39 cents a share, up from $356 million or 37 cents per share a year earlier. Revenue increased 10 percent.

American Express (AXP) posted a better-than-expected first-quarter profit, helped in part by higher spending by card members. AmEx’s net income attributable to shareholders fell to $1.21 billion, or $1.34 per share, in quarter ended March 31 from $1.39 billion, or $1.45 per share, a year earlier which included certain subsequently discontinued co-brand partnerships – also known as Costco.

AmEx faces cut-throat competition, particularly for premium customers, as card issuers offer ever richer levels of rewards to acquire and keep customers. The company last month fattened up rewards on its Platinum charge cards to fortify its high-end market.

BlackRock (BLK), the world’s biggest asset manager, reported double-digit profit gains as investors plowed money into lower-cost index funds, but the company’s share price slipped as revenue fell short of analysts’ expectations.

BlackRock’s assets grew 22 percent from a year ago to $5.4 trillion, fees for managing those assets and lending out the securities grew by a smaller 12 percent. Investors poured $82.2 billion into its index funds and iShares exchange-traded funds during the first quarter, while its pricier active funds posted $1.8 billion in withdrawals.

Blackrock CEO Larry Fink made the media rounds this morning and he certainly sounded happy about the quarterly results, but he was less sanguine about the economy overall. Fink said there are indications that the U.S. economy is slowing as businesses weigh whether the Trump administration will be able to pass tax reform and an infrastructure program quickly.

Morgan Stanley (MS), the sixth-largest U.S. bank, generated $1.7 billion in revenue from bond trading in the first quarter, the most in two years. The figure matched what Morgan Stanley had produced before cutting 25 percent of the business’s staff, showing that the bank can do more with less. The bank also delivered more from bond trading than arch rival Goldman Sachs, a rare feat.

Overall, the bank easily beat expectations, reporting a first-quarter profit of $1.8 billion, or $1 per share, up from $1.1 billion, or 55 cents per share, in the year-ago period, and topping estimates of 88 cents per share. Net revenue jumped 25 percent to $9.75 billion.

The major banks have now reported earnings. JPMorgan (JPM), Citi (C), Wells (WFC), Bank of America (BAC), and Morgan Stanley all beat consensus estimates. You know that game. Banks themselves had steadily walked down analysts’ expectations for almost three weeks leading up to the start of earnings releases, so it shouldn’t have come as a surprise that they magically beat forecasts.

A constant theme has been more trading and fewer loans. Citigroup handily beat earnings per share estimates but the bank’s net interest margin fell 3% to 2.74%, even though the Fed raised rates and net interest margin was supposed to be expanding.

Higher net credit losses at Citi were a weak spot, with consumer banking net credit losses globally up 17% year over year, and up a surprising 33% in North America alone. JPMorgan Chase had a similar EPS beat, topping analysts’ estimates by 8.5%, and had better than expected trading revenue too. But loan growth slowed across all categories.

Wells Fargo beat earnings estimates. While bank officials talked up Wells’ 18 straight quarters of at least $5 billion in revenues and the bank’s ‘highest in the industry’ return on equity and return on assets, it revealed that loan growth fell across the board.

Wells had some negative publicity in the quarter – Side bar here: We learned yesterday that the Office of the Comptroller of the Currency, America’s chief federal banking regulator admits it failed to act on numerous “red flags” at Wells Fargo that could have stopped the fake account scandal years earlier.

One particularly alarming red flag that went unheeded: In January 2010, the regulator was aware of “700 cases of whistle-blower complaints” about Wells Fargo’s sales tactics. The regulator did nothing.

Mortgage lending was down at the nation’s biggest housing lender.Auto lending originations were down 5.5% from the previous quarter and down a whopping 29% from last year’s Q1. At the same time, Wells’ employee count was up by 3700, even after closing almost 30 branches in the first quarter and after cutting 5300 heads because of the bank’s account opening scandal.

Under the fluff, here are the trends coming out of the banks’ earnings reports. Consumer and commercial loan demand is falling. Mortgage originations are going in the wrong direction. Auto loans are being pared back by banks themselves because of “heightened credit underwriting standards,” in response to early signs of rising delinquencies, according to Wells Fargo. Net interest margins haven’t expanded with rising rates.

And if the banks and the markets are slipping, it might not be too long before the economy starts slipping again.