Why falling bank profits aren't spooking investors

Investors braced for bad news as the Q1 earnings season kicked off this week. For good reason: FactSet data showed S&P 500 earnings were set for their worst performance since 2009 and the fourth consecutive quarterly decline. How bad? A 9.1 percent decline over last year.

Bank stocks were in focus on vulnerabilities surrounding net interest margins and M&A slowdown fears, both consequences of the Federal Reserve's first rate hike since 2006 in December.

But results from JPMorgan(JPM), Wells Fargo(WFC), and Bank of America(BAC) -- while suffering declines in revenues and earnings from last year -- weren't as bad as feared. And in this environment, less bad news is all that's needed to get stock prices moving higher.

Let's break it down.

On Wednesday morning, JPM reported earnings of $1.35 per share (a nine cent upside surprise) vs. $1.45 last year. Revenue fell 3.7 percent to $23.2 billion. Results were driven by better trading revenue, tight expense management, and solid loan growth. Investors were also comfortable with an increase in loan loss provisions driven by energy sector defaults. Concerns surrounding rates, market volatility, growth, and commodity headwinds all seemed to melt away.

On Thursday morning, WFC reported earnings of 99 cents per share (a one cent beat of expectations) vs. $1.04 a year ago. Revenues actually increased 4.2 percent from last year to $22.2 billion as the company continues to find traction in its mortgage origination business.

And finally, BAC reported in-line earnings of 21 cents per share on an eight percent year-over-year drop in revenue to $19.7 billion. Management noted limited credit quality declines outside of the oil and gas and materials sectors and noted an ongoing concentration on expense control as a way to boost below-peer return-on-equity.

One thing to watch for going forward is whether oil prices stay low, which would increase the financial pressure on weaker U.S. shale oil companies -- thereby putting the big banks' energy loan book at risk of default.

BAC, for instance, noted it has a $7.7 billion loan exposure to high risk energy exploration and production and oilfield services clients. Management increased their loan loss reserves against these loans by $525 million, covering 13 percent of this loan book. This comes right out of earnings.

Going forward, if more energy loans than expected end up defaulting, these reserves will need to be bolstered further potentially dragging down earnings in Q2 and beyond.

Another factor to consider is that M&A activity dropped to an eight-quarter low in Q1 of $254 billion from a record high of $756 billion in 4Q15. IPO activity has also stalled. Should this continue, it will pressure investment banking revenue and margins.

In the end, investors are pleased that declines in bank profits aren't as bad as feared; yet, earnings are still falling. And that's not exactly a good thing.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.