August 18, 2021

U.S. Earnings Growth Helped By Bank Reserve Releases

by Thomas Alonso.

As we have noted in prior research, the U.S. 2021Q2 earnings season has been a blockbuster in terms of blended growth rates. This quarter’s 93.8% year-over-year increase was the largest recorded since 2009Q4 with a record-tying number of constituents (87.4%) beating consensus EPS estimates. Additionally, revenue growth has been strong with 87.1% of constituents reporting a revenue beat relative to consensus estimates in 2021Q2, which is the highest beat rate on record.

If we dig beneath the surface and look at sector performance, the FAAMG stocks have provided a large boost to the year-over-year growth, which is not unexpected, given the benefits from the pandemic and the work from home environment.

What may be more interesting is the relative change for the bank sector in the S&P 500. In 2020Q2, the banks occupied three of the bottom ten spots in terms of their percentage point contribution to year-over-year growth in EPS, as the pandemic-driven slowdown in the economy led to massive loan loss reserve building. Fast forward one year and the banks are now meaningful contributors to year-over-year growth, occupying five of the top 10 spots, with the top 10 contributors accounting for 28.5 percentage points of the 93.8% total (see Exhibit 1 below).

 Exhibit 1: Top 10 Percentage Point Contributors to 2021Q2 YoY EPS Growth

While the EPS beats for the banks have been large, with an average surprise factor of 27.8% compared to the S&P 500 average surprise factor of 16.4%, revenue growth has been more difficult to come by. Year-over-year revenue growth for the banks in the S&P 500 has averaged 7.8% compared to the 24.3% blended growth rate for the S&P 500. Looking at revenue surprise factors, the banks do a little better with an average surprise factor in in 2021Q2 of 4.1% compared to 5.3% for the index.

Within Refinitiv Eikon, investors can use the Earnings Season app to monitor earnings season in real-time.  To access this app, type “EARN” in Eikon search.  The Earnings Season App allows you to monitor the current earnings season, detailing developing trends of companies that have already reported and how they may impact those yet to report. Analytics are displayed at the aggregate and company level to support idea generation.

Looking at data for the S&P 500 in the EARN app we see that 20213Q earnings for those companies that have reported have been revised up by 1% on average whereas those companies that are yet to report have seen their earnings estimates for the 3rd quarter increased by 6.4% over the past 30 days (see Exhibit 2 below).

Exhibit 2: Earnings Season App (EARN) – S&P500 by Sector

Source: Refinitiv Eikon

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Further within the EARN app, we can see that the average two-day performance for companies during this reporting season has been relatively flat despite most companies reporting a beat, with those that missed earnings being punished more (avg -0.9%) than those that beat earnings (avg -.5%).

We can also use the EARN app to sort by industry classification. Looking at just the banks, we see a similar theme play out, with two-day price reaction down on average and those banks that missed earnings being punished more (avg -4.5%) than misses in the broader market (see Exhibit 3 below).

Exhibit 3: Earnings Season App (EARN) – S&P500 Banks

Source: Refinitiv Eikon

We see revisions for bank EPS in 20213Q are generally flat to down likely reflecting the difficult top line environment and less reserve release going forward. Despite the slightly weaker earnings performance from the banks on a year-to-date basis the S&P bank index has outperformed the broader market by about 12 percentage points (see Exhibit 4 below) with a total return of 32.3% (orange line below) versus 20.0% for the S&P 500 (purple line below).

Exhibit 4: S&P500 Bank Index (.SPXBK, orange line) Total Return vs. S&P 500 (.SPX, purple line)

Source: Refinitiv Eikon

Looking a little deeper at the banks’ performance in the quarter, we see in Exhibit 5 below the provision expense for each member of the S&P Bank Index in 2Q for the last three years.

It is easy to see the dramatic increase in LLP expense in 2020Q2, when these banks set aside a total of $41.3 billion (pre-tax) in reserves, a 466% increase from the prior year. With an overall earnings decline for the group of $19.3 billion in 2020Q2, it’s plain to see that the large swing in LLP was the primary driver for the earnings decline.

In 2021Q2, banks released an aggregate of $7.5 billion from reserves, for a year-over-year decline of $48.9 billion compared to overall earings growth for the banks in 2021Q2 of approximately $28.2 billion, again showing that the change in provision expense is the primary driver for year-over-year growth in EPS for the banks.

Exhibit 5: S&P500 Bank Index Member LLP Expense

Source: Refinitiv Eikon

Given the still-difficult interest rate environment and expectations for weaker revenue growth, it will be interesting to see if investors continue to reward the banks for reserve releases in upcoming quarters, or if focus will shift to top line growth.

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