Did the fourth quarter of 2011 prove to be as messy and disappointing for banks as the previous quarter? We will know when JPMorgan Chase (JPM) officially kicks off the bank earnings season on Friday.
Expectations for the fourth quarter earnings season for the big banks are low, given that the weakness in capital markets activity has been well telegraphed.
Consensus expects the nation's biggest bank by assets to report earnings per share of 93 cents on revenue of $23.47 billion. That is down from earnings per share of $1.02 on revenues of $24.36 billion in the previous quarter and is lower still from a profit of $1.13 per share on revenue of $26.7 billion recorded in the fourth quarter of 2010.
Analysts have also factored in the tightening of spreads on banks' debt in the fourth quarter, which would likely result in debit-valuation losses. This is important because banks reported hefty accounting gains in the third quarter as spreads widened, a result of increasing concerns about their exposure to the euro zone.
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JPMorgan reported a $1.9 billion debit-valuation adjustment gain, so a loss this time would skew the quarter-to-quarter comparisons at first glance.
Concerns that the volatility in capital markets might persist has weighed on JPMorgan, even though the bank boasts a "battleship balance sheet" and has delivered above-average profitability through the crisis. Trading and investment banking contributed about 25% of revenues and about 40% of the profits for JPMorgan in 2010, so the fears are understandable.
Still, bulls tout the bank's well diversified business model and strong capital position as an advantage in a weak operating environment.
Morgan Stanley analysts on Monday highlighted JPMorgan as a top pick in any scenario. The stock benefits "as much as cheaper names in a bull outcome and its share gains and higher efficiency make it defensive in a bear outcome," the analysts wrote in a report.
Analysts will be looking for some positive indicators such as stronger mortgage origination revenue, continuing credit quality improvements, share gains in investment banking and greater expense-control as signs that the bank will be able to sustain its outperformance in a weak-growth environment.
One potential positive surprise in the earnings report could come from a significant loan loss reserve release, according to Stifel Nicolaus analyst Chris Mutsacio. JPMorgan has shown caution more recently in releasing reserves, with delinquency trends in consumer-related loan portfolios stabilizing rather than continuing to show improvement.
Still, with a reserve-to-loan ratio in excess of 4.0% at the end of 3Q11, the analyst believes that the management may have shown "an abundance of caution" last quarter.
Sandler O' Neill analyst Jeff Harte expects the bank to under-provide by $253 million versus $96 million in the previous quarter. But despite the reserve release, the bank will still have an ample reserve-to-loans coverage ratio of 4.3%, according to the analyst.
Looking forward, the market will also be hoping for more upbeat commentary from CEO Jamie Dimon, who always manages to strike a confident tone even though the headwinds for bank earnings just keep swirling higher.
Capital deployment plans has become the top theme for bank investors in 2012 and JPMorgan's management is bound to face questions on their plans, though they are unlikely to elaborate on them while the Fed's approval us still pending.
The bank is considered well placed to increase dividends/buybacks in 2012 even as it strives to build a Basel III Tier 1 Capital of close to 9% by the end of the year.
Deutsche Bank analyst Matt O'Connor expects JPMorgan's capital deployment will be the highest in 2012 because "capital remains strong" and is "building quickly." "We believe dividend increases could push yields closer to 4% in 2012 (vs. about 2% on average for banks) and additional buybacks should be meaningful (with a 2% decline in shares possible)," the analyst wrote in his outlook.
The other opportunity for JPMorgan in 2012 lies in Europe, as troubled banks in the region shrink their balance sheet by selling assets and pulling out of certain markets. JPMorgan has the flexibility in its capital to pick up assets. It will also be able to gain share "as Europe stress is driving consolidation around strong capital market players," according to Morgan Stanley analysts.
While expectations for the fourth quarter have been low, earnings forecasts for 2012 remain rosy. The six largest lenders, including JPMorgan, Bank of America (BAC) and Citigroup (C) may post an average profit increase of 57 percent this year, according to 184 analysts' estimates compiled by Bloomberg.
So while investors may be willing to give a forgettable fourth quarter a pass, the case for banks might be tested only when they report their first quarter results, traditionally a strong one for universal banks.
--Written by Shanthi Bharatwaj, reporter at TheStreet
