By Telis Demos 

The resilience of big banks' lending books may be the big news this quarter. But their Wall Street arms may not be getting enough credit for their own performance.

JPMorgan Chase and Wells Fargo have started doing what investors have been expecting, which is to release reserves for potential credit losses taken at the height of the pandemic's economic shock. Defaults haven't materialized to the levels feared, and the economy now looks to be on an upswing. JPMorgan released $5.2 billion worth of reserves in the first quarter, and Wells Fargo released $1.6 billion.

That is important to see, but ultimately these are paper profits, not more cash to be put to work. Reserve releases also don't necessarily get fully reflected back into the bank's core equity capital, since regulators gave banks a form of pandemic relief by delaying some of the impact of loss reserving on key capital levels.

It is core capital, not just earnings, that is needed to fuel banks' shares further, as growing deposits weigh down balance sheets. This is key to avoid constraints on future lending, when demand picks up, or buybacks, to boost returns in the meantime.

JPMorgan issued $1.5 billion worth of preferred shares in the quarter, as it had said may be needed to stay well clear of leverage-ratio minimum levels. It still repurchased net $4.3 billion worth of common shares in the first quarter, and said it looks to be able to do most of the roughly $7 billion net capacity for buybacks it has in the second quarter under Federal Reserve rules.

Given these constraints, the even better news for investors is that core Wall Street businesses are generating huge earnings without needing to use substantially more capital. That wasn't always the case, as volatility and volumes could sometimes force banks to take on even more risk to keep up. JPMorgan said corporate and investment bank's return on equity was 27% in the first quarter, up from 26% in the fourth quarter. That figure was just 14% at the end of 2019. At Goldman Sachs Group, global markets return on average common equity was up over 10 percentage points over the quarter, to about 27%.

This may be part of a larger shift on Wall Street after years of stepped-up regulation and technology change. A study by bank analysts at Morgan Stanley and consultants at Oliver Wyman found that in 2020, every dollar of revenue in markets and investment banking required 21% less balance sheet and 34% less value-at-risk than 10 years earlier. Good performance from capital efficient units such as merger advisory also helps.

Wall Street revenues may be near or at their cyclical high, but then again they may not be if the U.S. economy is about to enter a multiyear boom, as JPMorgan Chief Executive Jamie Dimon now says he expects. That should turn up plenty of opportunities for banks' trading desks, M&A advisers, and so on, not to mention their ordinary lending business.

On a price-to-tangible book value basis, JPMorgan and Goldman Sachs are trading near five-year highs. But on a price-to-forward-earnings basis, they are still significantly cheaper than the S&P 500, at about 59% and 43% of the index, respectively. Historically, such discounts have reflected banks' capital intensiveness and earnings volatility. But there are signs now that both are improving.

Banks have just been through a real-life stress test featuring a once-in-a-century pandemic and a surge in unemployment to double-digit levels. Their strong performance suggests banks' discount to the rest of the stock market may be bigger than it needs to be.

Write to Telis Demos at telis.demos@wsj.com

 

(END) Dow Jones Newswires

April 14, 2021 12:21 ET (16:21 GMT)

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