BAC Bank of America Corporation

The following is an excerpt from this week's Earnings Trends article.  To see the full report, please click here.

Banks in Focus as Q1 Earnings Season Ramps Up

The 2014 Q1 earnings season has gotten off to a relatively soft start. Low expectations essentially guarantee that we are unlikely to get any major negative surprises. But as with economic data, the market has likely moved past the Q1 numbers and is looking ahead to the coming periods when earnings growth is expected to accelerate.

The chart below shows the weekly schedule for Q1 results.

 
The focus in the coming days will be on the Finance sector, which was a stalwart growth contributor in recent quarters but is expected to see a decline in Q1. Total earnings for the Finance sector, the largest in the S&P 500 expected to bring in almost 1/5th of the index’s total earnings in 2014, are expected to be down -8.7% in Q1. This follows double-digit earnings growth for the sector in the last many quarters.

The earnings decline is particularly pronounced for the banking industry, the largest in the Finance sector accounting for almost 40% of its total earnings. Total earnings for the banking industry are expected to be down -17.1% from the same period last year. The brokerage industry, which accounts for about 1/10th of the sector’s total earnings, is expected suffer -6.8% decline in total earnings in the quarter.

A combination of effective cost controls, reserve releases, strength in the mortgage business and only modest improvement in the core business helped the banking industry scale its prior cyclical peak in profitability. As you can see in the chart below, total bank industry earnings are already past the prior peak, even though returns remain below those levels.

 
(Note: the data in the chart above pertains solely to the Zacks M-industry of ‘Major Banks’ – one of the 7 M-industries in the finance sector, which only includes the 15 major banks in the S&P 500. Regional banks and the pure-play brokerage firms are not part of the Major Banks industry and have their own industries. )

Estimates for the banks and brokers came down as it became increasingly obvious that weakness in the capital markets business will add to existing mortgage banking woes. The capital markets business, particularly on the fixed income side has been weak for a while and we will likely see a continuation of that trend in Q1, with fixed income revenues offsetting gains on the advisory sides. The ever present legal/compliance costs also don’t seem to be going away either and have effectively become a recurring part of the business model.

The negative estimate revisions for J.P. Morgan (JPM), Citigroup (C) and Bank of America (BAC) among the major banks and Goldman Sachs (GS) and Morgan Stanley (MS) among pure-play brokers in recent days all reflect these negative factors to varying degrees.

On the positive side for the banks, net interest margins appear to have stabilized and the demand outlook for commercial & industrial and real-estate loans has started improving. The overall size of loan portfolios will likely see limited growth, as growth in consumer categories like credit cards, mortgages and home-equity loans remain essentially non-existent. The growth in these categories in Q1 will likely be muted by seasonality factors, but the expectation is that management teams will talk up the outlook on that front for the rest of the year.   

Overall Q1 expectations remain low, with total earnings for the S&P 500 expected to be down -4.1% from the same period last year on +0.7% higher revenues and modestly lower margins. As has been the trend for more than a year now, estimates for Q1 came down sharply as the quarter unfolded. The current -4.1% decline in total Q1 earnings is down from +2.1% growth expected at the start of the quarter in January.

 
Current estimates for total S&P 500 earnings in Q1 are down from what was expected at the start of the quarter in early January. This magnitude of negative revision to Q1 earnings over the last three months is greater than what we witnessed in the comparable period in 2013 Q4, but is broadly in-line with the magnitude of the 4-quarter average of negative revision.

The chart below shows the magnitude of negative earnings revision for 2014 Q1 and each of the preceding four quarters over the course of each quarter.

 

Estimates for Q1 have fallen across the board, but the trend is particularly notable for the Retail, Basic Materials, Autos, Consumer Staples, and the Energy sectors, as the chart below shows.

 
With two-thirds of S&P 500 members typically beating earnings estimates in any reporting cycle, actual Q1 results will almost certainly be better than these pre-season expectations. But Q1 is unlikely to repeat the performance of the last few quarters when we would witness new all-time records for total earnings each quarter.

Guidance has been overwhelmingly weak for more than a year now, keeping the revisions trend firmly in the negative direction. Odds are that we wouldn’t see any change on that front this earnings season either, bringing down estimates for the rest of the year. Investors haven’t cared about negative estimate revisions thus far, but it will be interesting that behavior will remain in place going forward as well.

Key Points

• The 2014 Q1 earnings season has gotten underway with results from 26 S&P 500 members (with fiscal quarters ending in February) already out. The reporting cycle gets into high gear from next week onwards.
• Total earnings for the 26 S&P 500 companies that have reported results are up +12.3%, with 57.7% beating earnings expectations. Revenues for these companies are up +5.4%, with a revenue ‘beat ratio’ of 42.3%. The performance from these companies is weaker than what we have seen from this same group of companies in recent quarters.  
• For the S&P 500 companies as whole, total Q1 earnings are expected to be down -4.1% from the same period last year, on +0.7% higher revenues and 48 basis points in lower margins. Sequentially, total earnings for the S&P 500 are expected to be down -5.9%.
• Estimates fell sharply as the quarter unfolded, with the current -4.1% decline in total earnings down from expectations of +2.1% positive growth in early January.
• The growth weakness is broad-based and not concentrated in any one sector, with 10 of the 16 Zacks sectors expected to show earnings declines in Q1. Among the major sectors, earnings are expected at this stage to be down -8.7% in Finance, -7.2% in Technology, -6.7% in Energy, and -14.5% in Autos. Business Services and Utilities are the only sectors expected to show double-digit earnings growth.
• The Q1 earnings season is expected to be the low point of this year’s earnings picture, both in terms of total earnings as well as the growth rate. Total quarterly earnings reached an all-time record in 2013 Q4, but are expected to fall short of that level in 2014 Q1. Expectations for the coming quarters reflect a strong ramp up, with each of the following three quarters a new all-time record.
• Guidance has overwhelmingly been negative in recent quarters and we saw the same trend in place with the initial Q1 reports. Continuation of that trend through the rest of this earnings season will result in the by-now all-too-familiar negative revisions to estimates for 2014 Q2.
• Total earnings in Q2 are currently expected to be up +4.7%, followed by growth rates of +6.7% in Q3 and +8.7% in Q4. For the full year, total earnings are expected to be up +7.0% in 2014 and +11.9% in 2015.
• The bottom-up ‘EPS’ estimate for the S&P 500 for 2014 currently stands at $115.66, while the top-down estimate for the same is currently at $117.25. For 2015, the bottom-up estimate remains $129.36, with the top-down estimate from Wall Street strategists currently at $125.

To see the full Earnings Trends report, please click here.
 

 
BANK OF AMER CP (BAC): Free Stock Analysis Report
 
CITIGROUP INC (C): Free Stock Analysis Report
 
GOLDMAN SACHS (GS): Free Stock Analysis Report
 
JPMORGAN CHASE (JPM): Free Stock Analysis Report
 
MORGAN STANLEY (MS): Free Stock Analysis Report
 
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