Pro Perspectives 1/19/21

January 19, 2021

Fourth quarter earnings has kicked off with the big banks.  We heard from JP Morgan, Citi and Wells Fargo on Friday.  And today we heard from Bank of America and Goldman Sachs.

Were the numbers good?  Yes.  All beat earnings estimates.  Goldman had record revenues.  JP Morgan had record profits in the quarter.

Will the numbers get much better as we step through 2021, yes.  

Remember, if we look at the economic contraction of last year, the maximum drawdown in economic output, based on the Fed's quarterly readings, was $2.2 trillion.  During the same period, the Fed's balance sheet has expanded by $3.2 trillion.  And the Federal government doled out $2.2 trillion, with another $2.4 trillion coming down the pike (about $0.5 trillion of which is new money from the December aid, along with Biden's latest $1.9 trillion ask — which will all likely followed by another $1 trillion+). 

So, the easy math tells you, the response has far outweighed the damage

And no coincidence, the value of annualized GDP will have, by the end of this quarter, fully recovered all of the pandemic-induced losses. 

With the above in mind, the banks are big winners on a number fronts. 


First, the Fed's early and aggressive response to the economic lockdown addressed the stability of the banks immediately.  The banks were de-risked, as the Fed became the lender of last resort (the backstop).  Credit risks, worn by the banks, were transferred to the Fed.  Moreover, the Fed encouraged, if not forced, the banks keep liquidity flowing (make loans). 

So while the economy was in various stages of lockdown, business at the banks was good.  Deposits soared, mortgages and trading was hot and the banks made millions of ppp loans.  But as all of corporate America does, when things get broadly bad for the economy, you take any losses you can and you dial down expectations. In my July Pro Perspectives note, just ahead of Q2 bank earnings, we talked about this …

"We should expect all of corporate America to take this opportunity, in their Q2 earnings reports, to put all of the bad news they can muster on the table. 

In a widespread economic crisis, this is their chance to write down the value of anything they can justify, take loss provisions on as much as they can, and set the bar as low as they can, so that in the quarters ahead, they can outperform expectations… 

We'll see the kitchen sink of loan loss provisions (i.e. guesses on what losses may materialize in the future) in these reports.  They will put these out there, because they can.  But remember, the Fed, Treasury and Congress have already pumped trillions of dollars into the economy to keep consumers and businesses solvent. That's a direct backstop (protection) against these ‘provisional loan losses.’   

Add to that, the Fed has created tremendous revenue opportunities for the banks. They've eliminated the reserve requirement for banks — taking the ratio from 10% to zero.  The banks are now incentivized to make an infinite amount of loans.  The Fed has also become a buyer of corporate bonds, reducing risk in the credit markets, which has driven record first half volume in new corporate debt issuance.  That drives investment banking business at the big banks. And the liquidity deluge from the Fed has created a broad stock market boom, which drives trading revenue. 

With all of this said, don't be surprised if the bank earnings (ignoring loan loss provisions) come in better, and maybe much better, than expected." 

The above has all played out.  The banks did indeed build a war chest of capital.  And the banks did indeed set a low bar of expectations, that they've been beating handily. And now, with a recovering economy and even more stimulus dollars to flood the economy, the banks are in position to begin turning "loan loss provisions" into earnings — at their sole discretion. 

As an example, Citi did $11 billion in net income for the full year.  That’s after while setting aside $10 billion for loan loss reserves.  So, much of that $10 billion will ultimately find it's way to its proper home — the bottom line of the income statement.   

Now, add this fuel to the fire: The investment banking business has been red hot with the proliferation of SPACs and IPOs over the past year.  But I suspect that's nothing, compared to what's coming.  With a multi-trillion dollar clean energy economic transformation plan coming, under Biden and the Dem Congress, the investment banking business is positioned to boom, for the banks.