NEW YORK (Reuters Breakingviews) - U.S. mega-banks are all dressed up with few places to grow. Citigroup, JPMorgan and Wells Fargo kicked off the year with results that exceeded expectations. Some of the investor exuberance over possible tax cuts and regulatory rollbacks has abated, however. Loan growth is slowing and credit costs may soon rise. Valuations have further to fall.
First-quarter earnings on Thursday helped justify some of the momentum. JPMorgan generated annualized return on equity of 11 percent and Wells Fargo’s clocked in at 11.5 percent. That’s at the top end of what they have been delivering for a couple years. There’s little evidence yet of any Donald Trump or Janet Yellen effect.
Both lenders, along with Citigroup which also reported profit that beat consensus estimates, unveiled yet another decline in how much money it projects losing because of borrowers not being able to pay. These credit costs are now exceptionally low and will, as JPMorgan boss Jamie Dimon puts it, soon “normalize.”
Worrying signs are developing. Loan growth at JPMorgan slowed to just 1 percent from the fourth quarter while balances at Wells Fargo fell slightly. It’s a broader industry trend. Net new commercial and industrial lending has been close to flat for the past few months, according to Federal Reserve data.
The same is true of net new corporate debt issuance, according to UBS. Strip out financial borrowers and net investment-grade bond sales plummeted 39 percent by mid-March. And the banks keep losing mortgage business to the likes of Quicken Loans and loanDepot.
Some of these developments may be short-lived as companies digest changes – or lack thereof – from Washington. Along with the fallout from Trump’s failure to replace Obamacare, these have taken the edge off the post-election bank-stock rally.
Many still look excessive. JPMorgan trades about one-third above book value. That should, using rule-of-thumb valuation theory, correspond to an annual return on equity of 13 percent. According to estimates culled by Thomson Reuters, however, it won’t even breach 12 percent for at least two years.
There are similar discrepancies for Wells Fargo, Goldman Sachs, Morgan Stanley and others. Only Citi, which trades at 77 percent of its book value, closely corresponds with its 7.4 percent annualized first-quarter profitability. Unless the nation’s lawmakers enact some new rules, as is eagerly anticipated, those valuation gaps should close.
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