Financial Review

Inside Bank Earnings

Sinclair Noe — April 19, 2017

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DOW – 118 = 20,404
SPX – 4 = 2338
NAS + 13 = 5863
RUT + 5 = 1367
10 Y + .02 = 2.20%
OIL – 1.83 = 50.58
GOLD – 8.90 = 1281.30

Energy stocks were under pressure Wednesday as crude-oil prices settled at a two-and-a-half week low and its biggest one-day loss in 6 weeks. Gasoline inventories posted a surprise increase, a counter-seasonal build of 1.5 million barrels in the latest week, along with an increase in U.S. production. The energy sector was the worst performer among the S&P 500 index’s 11 sectors.

Shares of International Business Machines were largely responsible for a decline in the Dow industrials. IBM lost about 5%, after posting its 20^th consecutive quarter of declining revenue. IBM has an outsize impact because the Dow is price-weighted, meaning the most expensive stocks (rather than the largest companies) have the biggest pull.

Monday’s rally was on low volume, a sign of weakness. Yesterday’s selloff saw volume increase. In the U.S. Treasury market, bond yields rose after a rally on Tuesday sent yields to five-month lows.

The Federal Reserve publishes the Beige Book two weeks prior to FOMC monetary policy meetings. The Beige Book gathers anecdotal reports from the 12 Fed districts; not hard economic data, rather observations and remarks.

Today’s  Beige Book found “a larger number of firms mentioned high turnover rates and more difficulty retaining workers.” Tight labor markets are broadening out wage gains but price pressures remain modest. A couple of districts said that worker shortages and increased labor costs were restraining growth in manufacturing, transportation and construction but overall inflation was modest, the report said.

Selling prices rose only slightly.  The information suggested somewhat softer readings in non-auto consumer spending and an expansion in the manufacturing sector. Home building accelerated and energy-related businesses reported “improved conditions.” Uncertainty about tax-and-spending policies was one factor mentioned in several districts as a restraint on activity.

Federal Reserve Vice Chairman Stanley Fischer today said there’s been a “benign” foreign market reaction to the central bank’s two rate hikes in four months. Fischer said: “The main reason for the positive market reaction is that foreign output expansions appear more entrenched, and downside risks to those economies noticeably smaller than in recent years.” He pointed out that European unemployment has fallen and China’s economy also is on a more solid footing.

He says there’s a chance foreign economies kick into gear enough that U.S. and foreign business conditions become aligned, as they did during the tightening cycles that began in 1999 and 2004. “A gradual and ongoing removal of accommodation seems likely both to maximize the prospects of a continued expansion in the U.S. economy and to mitigate the risk of undesirable spillovers abroad.”

Boston Fed President Eric Rosengren says the Fed should start shrinking its balance sheet relatively soon but do it so slowly that it doesn’t disturb the central bank’s plans to continue to gradually raise short-term interest rates. The Fed amassed $4.5 trillion in Treasury and mortgage-related assets in the wake of the financial crisis to push down long-term rates. Officials believe the balance sheet is still boosting economic conditions.

With the economy on more solid footing, the central bank wants to allow the balance sheet to shrink to a more neutral size. Rosengren suggested the Fed should initially retire a small percentage of maturing securities and then very gradually shrink the volume of the securities being reinvested. This confirms that asset purchases are now part of the Fed’s playbook and may be used again in the future; and that this Fed believes in gradualism; no sudden movements to spook the markets.

Earnings season rolls on.

eBay net income rose to $1.04 billion, or 94 cents per share in the first quarter, from $482 million, or 41 cents per share, a year earlier, but they lowered guidance, forecasting current-quarter profit largely below expectations, sending its shares down as much as 4.5 percent in extended trading.

Ebay said it expects current-quarter adjusted profit of 43-45 cents per share. Analysts on average were expecting 47 cents per share. EBay has been facing relentless competition from much larger rival Amazon. To lure more shoppers and better compete with Amazon as well as traditional retailers, the company has made several changes to its platform.

Qualcomm, the largest maker of chips used in smartphones, reported 9.6 percent fall in quarterly revenue, hurt by an arbitration decision to pay Canada’s BlackBerry for previously received royalties. Net income attributable to the company fell to $749 million, or 50 cents per share, in the second quarter ended March 26, from $1.16 billion, or 78 cents per share, a year earlier.

No. 3 U.S. railroad CSX Corp reported a better-than-expected quarterly net profit driven by rising freight volumes across most of the markets it covers and said it plans to cut costs and boost profitability moving forward. CSX posted first-quarter net profit of $362 million or 39 cents a share, up from $356 million or 37 cents per share a year earlier. Revenue increased 10 percent.

American Express posted a better-than-expected first-quarter profit, helped in part by higher spending by card members. AmEx’s net income attributable to shareholders fell to $1.21 billion, or $1.34 per share, in quarter ended March 31 from $1.39 billion, or $1.45 per share, a year earlier which included certain subsequently discontinued co-brand partnerships – also known as Costco.

AmEx faces cut-throat competition, particularly for premium customers, as card issuers offer ever richer levels of rewards to acquire and keep customers. The company last month fattened up rewards on its Platinum charge cards to fortify its high-end market.

BlackRock, the world’s biggest asset manager, reported double-digit profit gains as investors plowed money into lower-cost index funds, but the company’s share price slipped as revenue fell short of analysts’ expectations.

BlackRock’s assets grew 22 percent from a year ago to $5.4 trillion, fees for managing those assets and lending out the securities grew by a smaller 12 percent. Investors poured $82.2 billion into its index funds and iShares exchange-traded funds during the first quarter, while its pricier active funds posted $1.8 billion in withdrawals.

Blackrock CEO Larry Fink made the media rounds this morning and he certainly sounded happy about the quarterly results, but he was less sanguine about the economy overall. Fink said there are indications that the U.S. economy is slowing as businesses weigh whether the Trump administration will be able to pass tax reform and an infrastructure program quickly.

Morgan Stanley, the sixth-largest U.S. bank, generated $1.7 billion in revenue from bond trading in the first quarter, the most in two years. The figure matched what Morgan Stanley had produced before cutting 25 percent of the business’s staff, showing that the bank can do more with less. The bank also delivered more from bond trading than arch rival Goldman Sachs, a rare feat.

Overall, the bank easily beat expectations, reporting a first-quarter profit of $1.8 billion, or $1 per share, up from $1.1 billion, or 55 cents per share, in the year-ago period, and topping estimates of 88 cents per share. Net revenue jumped 25 percent to $9.75 billion.

The major banks have now reported earnings. JPMorgan, Citi, Wells, Bank of America, and Morgan Stanley all beat consensus estimates. You know that game. Banks themselves had steadily walked down analysts’ expectations for almost three weeks leading up to the start of earnings releases, so it shouldn’t have come as a surprise that they magically beat forecasts.

A constant theme has been more trading and fewer loans. Citigroup handily beat earnings per share estimates but the bank’s net interest margin fell 3% to 2.74%, even though the Fed raised rates and net interest margin was supposed to be expanding.

Higher net credit losses at Citi were a weak spot, with consumer banking net credit losses globally up 17% year over year, and up a surprising 33% in North America alone. JPMorgan Chase had a similar EPS beat, topping analysts’ estimates by 8.5%, and had better than expected trading revenue too. But loan growth slowed across all categories.

Wells Fargo beat earnings estimates. While bank officials talked up Wells’ 18 straight quarters of at least $5 billion in revenues and the bank’s ‘highest in the industry’ return on equity and return on assets, it revealed that loan growth fell across the board.

Wells had some negative publicity in the quarter – Side bar here: We learned today that the Office of the Comptroller of the Currency, America’s chief federal banking regulator admits it failed to act on numerous “red flags” at Wells Fargo that could have stopped the fake account scandal years earlier.

One particularly alarming red flag that went unheeded: In January 2010, the regulator was aware of “700 cases of whistle-blower complaints” about Wells Fargo’s sales tactics. The regulator did nothing.

Mortgage lending was down at the nation’s biggest housing lender.  Auto lending originations were down 5.5% from the previous quarter and down a whopping 29% from last year’s Q1. At the same time, Wells’ employee count was up by 3700, even after closing almost 30 branches in the first quarter and after cutting 5300 heads because of the bank’s account opening scandal.

Under the fluff, here are the trends coming out of the banks’ earnings reports. Consumer and commercial loan demand is falling. Mortgage originations are going in the wrong direction. Auto loans are being pared back by banks themselves because of “heightened credit underwriting standards,” in response to early signs of rising delinquencies, according to Wells Fargo. Net interest margins haven’t expanded with rising rates.

And if the banks and the markets are slipping, it might not be too long before the economy starts slipping again.

Financial Review

Understanding Global Banking

Sinclair Noe — June 11, 2015

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DOW + 38 = 18,039
SPX + 3 = 2130
NAS + 5 = 5082
10 YR YLD – .10 = 2.38%
OIL – .87 = 60.56
GOLD – 3.60 = 1183.00
SILV + .02 = 16.13

Retail sales rose 1.2% in May on a seasonally adjusted basis.  Auto dealers and gasoline stations posted the strongest sales, but most major retail segments saw healthy gains. What’s more, sales in April and March were stronger than initially reported. Sales at auto dealers rose 2%; the auto sector generates about one-fifth of all retail spending. Sales were up 3.7% at gasoline stations as the price of fuel crept higher. Even if autos and gasoline are excluded, retail sales rose a healthy 0.7%.

Separately, the Federal Reserve reports household debt grew just 2.2% in the first quarter, as a 0.3% fall in mortgage debt offset a 5.6% rise in auto loans, student loans and credit cards. At the same time, real estate value increased by $411 billion. The net effect is that household net worth jumped $1.6 trillion. Meanwhile, corporate debt grew at a 7.2% seasonally adjusted annual rate in the first quarter as businesses pile on debt before a possible Fed rate increase.

The number of US workers who applied for unemployment benefits in the first week of June edged up by 2,000 to 279,000. Claims have been below 300,000 for 14 weeks in a row, a feat last accomplished 15 years ago.

The prices the US paid for imported goods increased a seasonally adjusted 1.3% in May, entirely because of a sharp increase in fuel costs. It was the first increase in 11 months and the largest in more than three years. Fuel imports jumped 11.8%, the biggest increase since mid-2009, although oil is far less expensive compared to one year ago. Excluding fuel, import prices were unchanged last month.

The World Bank has joined the International Monetary Fund in urging the Federal Reserve to hold off on a rate hike until next year to avoid worsening exchange rate volatility and crimping global growth. The World Bank downgraded its outlook for global economic growth this year, lowering its forecast by 0.2% to 2.8%. The bank expects growth of 3.3% in 2016. The World Bank cut its 2015 forecast for the US economy by 0.5% to 2.7%, saying bad winter weather sapped output in the first quarter despite the economy now gathering steam.

German bunds fell again today, extending a sell-off that has pushed 10-year yields above 1% for the first time since September. The 10-year yield on German bunds edged higher to 1.02%, up sharply from the all-time low of 0.05% hit in April.

The outlook for the Greek economy seems to change day by day, sometimes hour by hour. Today, Greek stocks posted their biggest jump since February, pushing European equities higher for a second day. After a new round of late-night talks with the leaders of Germany and France, Greek PM Alexis Tsipras pledged to work intensively with creditors in coming days to solve all open issues holding up the country’s access to bailout loans. And then today, the IMF said “major differences” remain with Greece over an agreement and there was “no progress in narrowing these differences recently, and thus we are well away from an agreement.” So, the IMF negotiating team has left the talks in Brussels. Meanwhile, S&P lowered Greece’s credit rating to CCC from CCC+ yesterday, stating that Athens will likely default on its debt within twelve months. Athens’ ATG stock index +7.3%.

Greece is not the only one in hot water. Ukraine’s leadership on Wednesday warned that the likelihood of prolonged conflict against Russian-backed separatists and deadlocked creditor negotiations could threaten the West’s $40 billion bailout program. Ukraine is asking for a 40% cut in the face value of the bonds but creditors say no way. Kiev also declared it’s ready to impose a moratorium on foreign debt payments if necessary.

South Korea’s health ministry reported 14 new cases of Middle East Respiratory Syndrome (MERS), taking the total to 122. The rising numbers have sparked concern both within South Korea and across the region. Hong Kong issued a “red alert” advisory against non-essential travel to South Korea, while Singapore Airlines said it would waive fees for customers who want to cancel or re-book flights to South Korea. Today, the Bank of Korea policymakers cut interest rates by a quarter of a percentage point to 1.5 percent, the second rate cut this year, because the MERS virus could hurt businesses and dent consumptions as travelers cancel trips and people stay home out of worries of contagion.

If you’re looking for stock rockets, look no further than Asia. The Shenzen Index is up 146% in the past year. That may be a bit too volatile for most people. Meanwhile, the Nikkei Index in Japan is posting one year gains of 35%; and it has been a wild ride. The past 19 trading sessions included 12 consecutive sessions where the index was up. It was the longest stretch of consecutive days of gains in 27 years in Japan. After a 12-day run, the Nikkei fell six out of the next seven days. You might think a multi-day string of gains would signal a top in the market, but that isn’t necessarily the case. The Nikkei has seen many occasions where it has had 8-day winning runs, and it is more likely to result in a rally than a top. Going back over 35 years, the Nikkei outperforms following multi-day winning streaks, in fact it is more likely to double the performance of time frames without multi-day winning streaks. No guarantees, of course, but it’s the old idea that a trend in place is more likely to continue than reverse…, until it reverses.

New York law enforcement officials have written to eBay and PayPal this week, saying the companies’ revised user policies “raise issues” under consumer protection laws. The updated user agreements would allow the two firms to call or text their combined 322 million users for offers and promotions, to collect a debt or to poll their opinions through questionnaires. eBay’s new user agreement is scheduled to take effect on Monday and PayPal’s will become effective on July 1. The truth is that nobody ever reads those agreements, which means they aren’t really agreements at all.

Rupert Murdoch is preparing to step down as chief executive officer of 21st Century Fox and hand the CEO title to his son James. While it’s unclear whether a reorganization would happen this year or at the start of 2016, Murdoch would stay as chairman.

General Motors will make an announcement next week on a secondary use for electric vehicle batteries. GM’s initiative will involve extended use of EV batteries. Most lithium-ion batteries used in electric vehicles can last about 10 years, which is longer than many of those who lease the vehicles will drive them. Because the batteries still have about 70% of their capacity at the end of their driving cycle, either GM or the owners could sell the batteries to recoup some of their cost. Think something along the lines of the Tesla PowerWall, or some way to use the batteries to store energy in one form or another; anything that would help extend the life of the battery and therefore bring down cost.

California is sinking; it’s because of the drought. Last summer, scientists recorded the worst sinking in at least 50 years. This summer, all-time records are expected across the state as thousands of miles of land in the Central Valley and elsewhere sink. The extent of the problem and how much it will cost to fix are part of the mystery of the state’s unfolding drought. No agency is tracking the sinking statewide, little public money has been put toward studying it and California allows agriculture businesses to keep crucial parts of their operations secret.

The cause is known: People are pulling unsustainable amounts of water out of underground aquifers, primarily for food production, and tens of thousands of square miles are deflating like a leaky air mattress, inch by inch. Groundwater now supplies about 60 percent of the state’s water, with the vast majority of that going to agriculture. Tens of thousands of groundwater pumps run day and night, sucking up about 5 percent of the state’s total electricity; that’s an increase of 40 percent over normal years – or enough electricity to power every home in San Francisco for three years.

The US Court of Appeals in Washington denied a request from broadband providers to delay the implementation of rules adopted by the FCC to ensure an open internet; that means that net neutrality rules go into effect tomorrow. The internet will not slow down or grind to a halt and you won’t have to pay more for what you’ve been getting. Nothing changes, and that is kind of the point.

JPMorgan Chase CEO Jamie Dimon isn’t sure Sen. Elizabeth Warren understands how banking works. Warren is a Senate Banking Committee member, who has challenged the size of large lenders and their political power. She has said it was a mistake for the government to refrain from breaking up big banks after the 2008 financial crisis. Last month, as firms including JPMorgan pleaded guilty to resolve probes into market-rigging, she criticized regulators for granting waivers that let the companies continue operating certain businesses.

At an event in Chicago on Wednesday, Dimon said, “I don’t know if she fully understands the global banking system.” I think I have to agree with Jamie Dimon on this one. If Warren fully understood banking, she would have looted billions of dollars in a bubble inflated through accounting control fraud, crashed the economy, orchestrated the largest upward transfer of wealth in world history in the bailouts, paid herself a big bonus out of the bailout money, and become a billionaire in an industry where net profits equal government subsidies. And then paid millions to buy politicians to push back on regulations, while rigging every market from Libor to Forex to…, well every market. That’s what understanding banking means.

Tuesday, April 29, 2014 - Lowering the Bar

Financial Review with Sinclair Noe

DOW + 86 = 16,535
SPX + 8 = 1878
NAS + 29 = 4103
10 YR YLD + .02 = 2.69%
OIL - .12 = 100.72
GOLD - .40 = 1296.90
SILV - .13 = 19.54

The S&P/Case-Shiller home price index for February showed prices up 12.9% from February a year ago, that’s down from the 12-month advance of 13.2% reported in January. The index tracks existing home sales in 20 major metropolitan areas, and this economic report tends to lag, plus it is a 3-month moving average of prices; so maybe we could be seeing one of the last reports to reflect bad winter weather.

Home prices fell in 13 of the 20 cities in February compared with the previous month, and it wasn't just cold weather cities; prices in Las Vegas dipped 0.1% in February from the previous month, the city's first monthly decline in nearly two years; home prices fell 1.6% in Cleveland and 0.7% in Tampa, Florida. Las Vegas still posted the biggest 12-month gain, with an increase of 23.1%.

The Conference Board said its index of consumer attitudes dipped to 82.3 from an upwardly revised 83.9 in March; still, very near a 6-year high.

A new report today from the National Employment Law Project finds that as the economy has inched toward recovery, low-wage jobs have returned far more quickly than middle- or high-income work. The report’s finding shows how the housing sector in particular is a key middle-income employer that has failed to rebound.

Employment among specialty trade contractors, who earn a median wage of $20.03 an hour, is still down 22%. The number of workers who manufacture wood products, with a median pay of $14.94 an hour, is down 27%. Jobs working in rental and leasing services, with a median wage of $14.17 an hour, are down 16.3%. Employment in “credit inter-mediation and related activities,” which includes mortgage lending, is down 7.1%. Those jobs pay a median wage of $18.51 an hour.

Home-builders have been slow to pick up the pace of construction, which in turn is squeezing the housing market. Without good job growth among younger and middle class workers who would be first time home buyers, builders are focusing on higher-end projects, which is a smaller market. It’s the old idea that workers need to be paid enough to buy the products they make, otherwise, the market falters, and it becomes harder and harder to break out of the downward cycle.

The Federal Reserve FOMC is meeting today and tomorrow. The outcome is expected to be rather boring; more of the same; reduce the amount of money it is pumping into the economy by another $10 billion per month. The Fed’s purchases of long-term bonds, known as quantitative easing, are widely expected to end in the fourth quarter of this year. The steady phase-out has become routine and predictable. It will only become interesting if the Fed goes off script.

The US treasury reports the biggest debt pay-down in 7 years. The drop in net marketable debt will be $78 billion in the April-June period, $38 billion more than the pay-down projected three months ago, with an end-of-June cash balance of $130 billion. That trend may be temporary. A faster pace of hiring and soaring corporate profits are lifting tax receipts while spending increases at a slower pace. That’s helping shrink a budget deficit projected this year to be the smallest as a share of the economy since 2007. (Considering what followed, maybe we shouldn't rush to pay-down.)

The majority of S&P 500 companies are reporting better than expected earnings, albeit on lowered expectations; that’s the plan, lower the bar and step right over it.  Easy, right? Not always.

Twitter stumbled today, posting a first quarter loss of $132 million or 23 cents per share, compared to a loss of $27 million or 21 cents per share a year earlier. Revenue more than doubled to $250 million but it wasn’t enough. Shares were hit by 9% in after-hours trade.

EBay posted a loss of $2.3 billion compared to profit of $677 million a year ago. Revenue rose 14%, but shares dropped nearly 4% in after-hours trading.

A number of health-care related companies reported earnings today. Here’s a quick summary. Merck beat estimates by 9 cents; share price was up about 3%. Bristol Meyers Squibb beat earnings estimates but revenue missed expectations; shares down 3%. Cubist Pharmaceuticals posted a 30 cent per share profit, while analysts had expected a loss; shares up 4%. HCA Holdings’ earnings came in one penny short and then they lowered guidance; shares down 4%.

Pfizer has bid $100 billion for AstraZeneca, the biggest and latest in a series of proposed big pharma mergers. Traders and investors love big mergers because it represents a possible liquidity event, mainly for the party being acquired. Earlier this month, Valeant Pharmaceuticals offered to buy Allergan in a deal valued at more than $45 billion, while Novartis sold and exchanged business units with Eli Lilly and GlaxoSmithKline. And Mallinckrodt bought Questcor Pharmaceuticals for $5.6 billion. On Monday, Forest Laboratories, which has been offered $25 billion by Ireland's Actavis PLC, said it would offer up to $1.5 billion for Furiex Pharmaceuticals.

What does this mean for the industry and consumers? Not much good. The Pfizer-AstraZeneca deal is mainly about taxes. Pfizer would become a British company by combining with AstraZeneca, lowering the new company's tax rate dramatically. There's even a euphemism for this kind of move. It's called a tax inversion in the trade. Pfizer's tax rate was about 27% last year. In the UK the corporate tax rate stands at 21% and will fall to 20% in 2015. The tax code provides an incentive for US-based companies to move overseas, often times taking good jobs with them. That also means there might be political opposition to the Pfizer-AstraZeneca deal from Washington.

Yesterday, the Obama administration announced a new round of sanctions to punish Russia, even as it acknowledged that sanctions are unlikely to bring an immediate change in Russian behavior. The new measures froze the assets of 7 Russian individuals and 17 companies associated with them, and prohibited any US dealings with them; all were identified as closely linked to Russian President Vladimir Putin. The administration also announced new restrictions on Russia’s import of US goods deemed to contribute to its military capabilities. The European Union said it would expand its sanctions list to include 15 more individuals.

The Russian stock market moved higher today; call it a relief rally. Putin responded by threatening to reconsider Western participation in energy deals in Russia where several western energy companies have big projects underway or planned. ExxonMobil has a deal with Rosneft to explore and develop shale oil fields in the Artic, with a potential of 9 billion barrels in reserves; that would put the value at as much as $900 billion. The sanctions leave Exxon in business with a group headed by a man who’s not allowed into the US. Drilling was scheduled to start in August; might not happen now.

Meanwhile, a New York based investment firm, Goldentree Asset Management is buying Russian bonds, saying the securities offer value after suffering a 5.4% selloff this year. Russian dollar-denominated corporate bonds are yielding 7.2%, up from 5.8% at the end of last year. Patriotism be damned in the chase for yield.

The Supreme Court has breathed new life into Environmental Protection Agency rules targeting air pollution that drifts across state borders, handing a victory to the Obama administration on one of its major environmental efforts. The agency for years, under two administrations, has struggled to carry out a directive under the federal Clean Air Act to protect downwind states from pollution generated in other states, mostly from coal-fired power plants. The EPA’s rules from 2011 were challenged by a coalition of upwind states and industry, which prevailed in lower courts.

In determining how much individual upwind states should be required to reduce their emission, the EPA’s interpretation of the law allows for several factors to be considered, including what it will cost and how much the state has already done to cut pollution. A lower court ruling disagreed with this approach and said the reductions must be proportional to the state’s share of responsibility for downwind problems. In a 6-2 ruling, the Supremes determined the EPA must have leeway to confront the complex challenge of interstate pollution.

Energy Future Holdings has filed for Chapter 11 bankruptcy protection. Energy Future Holdings owns TXU Energy, which has the largest share of the Texas retail electricity market, and Luminant, the state’s largest power generator; the company also has about $40 to $50 billion in debt; making this one of the biggest corporate bankruptcy cases in US history.

Energy Future’s troubles can be traced back to its bet that natural gas prices would rise, helping it repay the interest and loans it took to acquire TXU Energy in 2007, but a glut of US shale production has instead brought natural gas prices to record lows, hurting the company’s bottom line and its ability to pay its debt. And even while natural gas prices spiked sharply higher last winter as bands of arctic air froze broad swaths of the country, it was simply too little, too late. Recently, it skipped a deadline to pay $109 million in interest.

A crucial part of the restructuring is a $7 billion tax liability hanging over Energy Future’s head. When the company took over TXU in 2007, the new stakeholders were spared having to pay that federal tax bill on the acquisition. However, the terms of the deal stipulated that if the company split up, the massive tax bill would come due.  Stakeholders hope they have reached a restructuring framework that will allow them to shed some of their assets without having to pay that tax, and have asked the IRS to rule on their request.