Banks are financial firms whose performance rises and falls with the economy. This means that their share prices are also interesting as cyclical investments.
The Four Large U.S. Commercial Banks
Banks report quarterly financial statements to federal regulators. These financial statements include information unique to banking that goes beyond the standardized accounting financial statements. The Federal Financial Institutions Examination Council (FFIEC) is a federal agency that coordinates this banking data across the federal bank regulators. It manages the National Information Center (NIC), a repository of financial data and institution characteristics collected by the Federal Reserve System.
A good place to start in comparing banks is to look at asset size. Because banks are financial intermediaries that collect funds (like deposits) and invest funds (like loans), the size of their balance sheet reflects the scale of their business operations. Banks are “balance sheet lenders.” In other words, the traditional bank business model involves making loans and holding those loans as assets on the bank’s balance sheet. This is in contrast to other types of financial institutions that connect borrowers and investors rather than putting the loan on their balance sheet.
To compare bank asset size, we need to look at the level of the holding company. Banks often have multiple entities within a single ownership structure. A bank holding company is the legal entity that owns all of these subsidiaries.
The four largest bank holding companies in the U.S. by asset size based on NIC data are:
- J.P. Morgan Chase ($3.25T)
- Bank of America ($2.75T)
- Citigroup ($2.25T)
- Wells Fargo ($2T)
These are all universal banks that include retail, commercial, corporate, and investment banking. These are the “big four” in banking.
Goldman Sachs and Morgan Stanley, two investment banks, are listed number 5 and 6, respectively, in the list of banks by asset size. The largest regional bank is U.S. Bancorp, which is number 7 by assets. U.S. Bancorp is based in Minneapolis, MN and primarily serves the Midwest region.
Market capitalization (number of shares multiplied by price of shares) is a an alternative measure of firm size that measure’s a firm’s market value. This is the equity size or net worth of a firm.
Shares of these four largest banks are all traded in the U.S. stock market. The same four banks listed by market capitalization (among the ranking of the world’s largest banks) are:
- J.P. Morgan Chase ($433.5B)
- Bank of America ($306.7B)
- Wells Fargo ($203.3B)
- Citigroup ($171.5B)
J.P. Morgan Chase and Bank of America are the largest banks in the world. Two Chinese banks, Industrial & Commercial Bank of China and the China Construction Bank are larger than Wells Fargo and the Agricultural Bank of China is larger than Citigroup. The largest European bank is HSBC, which is the next largest bank after Citigroup.
Asset size of the largest banks are in “trillions” and market capitalization is in “billions.” The difference between assets and equity is liabilities (assets = liabilities + equity). This indicates that banks are leveraged. Note that Wells Fargo is larger than Citigroup in market capitalization, but not in asset size. This indicates that Citigroup operates with greater leverage (more debt) than Wells Fargo.
Bank Share Prices
All four of the largest U.S. banks are listed on the New York Stock Exchange (NYSE). The stock tickers for these banks are J.P. Morgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C).
Banks are cyclical stocks. This means that their valuations rise and fall along with the business cycle. They are “pro-cyclical.” In particular, bank share prices are closely related to the level of interest rates. When long-term rates are high, banks can generate higher interest income on their loan portfolio. When long-term rates are low, banks have difficulty generating interest income. In general, the low-rate environment has put downward pressure on bank stocks. As rates have begun to rise again, banks stocks are also rising.
Bank Earnings
Bank profit is affected by loan loss reserves. Loan loss reserves are money that is set aside to absorb expected loan losses. When banks make loans, they have a financial model to estimate probability of default (PD) and expected loss given default (ELGD). Based, on this model, banks set aside funds to absorb these expected loan losses. Sometimes the losses are worse than expected and sometimes the losses are less than expected. When the losses exceed loan loss reserves, the losses are absorbed by bank capital. When losses are less than expected, then banks can release some of their loan loss reserves. Releasing loan loss reserves will benefit profitability.
Recent Bank Earnings Announcements
Publicly-traded banks release quarterly earnings just like other publicly-traded companies. The key profit metric is earnings per share. Equity analysts produce estimates for quarterly earnings per share prior to earnings announcements. This is a form of information and guidance to investors. Firms often release quarterly earnings before or after trading hours. This is “before the bell” and “after the bell,” respectively.
J.P. Morgan Chase (JPM) released its fourth-quarter and full-year 2020 financial results on January 15, 2021 at 7:03am ET.
The Nasdaq page for JPM earnings states that the analyst consensus for JPM’s Q4 (fiscal quarter end Dec 2020) was 2.72. Actual earnings per share was 3.79, a positive surprise of 39.34 percent.
The WSJ reported that “JPMorgan Profit Soars 42% After Bank Releases Reserves for Bad Loans” but noted “Still, CEO Jamie Dimon says bank remains positioned for `significant near-term economic uncertainty.'”
Like other publicly-traded firms, J.P. Morgan has an investor relations website with their quarterly earnings announcement information and a recorded conference call.
J.P. Morgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC) all released positive earnings for the fourth quarter of 2020 (4Q2020) on January 15, 2021. All of the banks’ quarterly income benefited from “releasing” some loan loss reserves that had been set aside for expected losses due to COVID. Banks expected COVID losses to be worse than they were, so banks were able to reduce some of their loan loss reserves in Q4.
As banks view credit risk to be falling with the economic recovery, they are able to reduce the amount of risk-mitigating loan loss reserves. This should increase returns through the remainder of 2021.