If liquidity is the lifeblood of financial markets, then banks represent the circulatory system. Distilling bank earnings offers investors interesting clues as to the underlying health of the financial markets. Q1 bank earnings came in mixed, as expected. JP Morgan demonstrated its market leadership by delivering a bottom-line result that blew away analysts’ expectations. Wells Fargo, meanwhile, stumbled: it beat analysts’ profit forecasts, but witnessed declines in loans, deposits and assets. The beleaguered bank suffered a slew of Wall Street downgrades in response. Bank of America delivered a back-door earnings improvement by lowering expenses and buying back $6.3 billion of BAC shares, but investors weren’t impressed. US Bank came through the quarter in line with expectations.

Parsing managements’ expectations for the remainder of the year is a key component in reading the earnings tea leaves. As with earnings performance, there are winners and losers. JP Morgan CEO Jamie Dimon offered an optimistic assessment, citing a strong jobs market, low inflation and robust business and consumer confidence. Bank of America’s CFO Paul Donofrio implied his bank is facing headwinds like tepid loan growth and revenue challenges. Wells Fargo will have its hands full looking for a new CEO.

Broadly speaking, credit conditions remain robust as evidenced by the top banks’ loan loss reserves, which are small in absolute terms. Collectively, JP Morgan, Bank of America, Wells Fargo, Citigroup and US Bank expanded their reserves 31 per cent over the last year to $5.6 billion. To put this in perspective, current loan loss provisions represent only 0.15 per cent of total loans, a far cry from the 1.2 per cent peak reached at the height of the financial crisis.  Among the largest banks, loan loss provisions as a share of total loans are highest at Citigroup (0.27 per cent) and lowest at Wells Fargo (0.09 per cent).  Given the new regulatory regime, industry reserves in excess of 0.20 per cent could be an early warning indicator – but it would take another $2 billion of additional provisions among these five banks to get our attention. There’s certainly no indication from the Q1 earnings reports that banks are hesitant to lend.

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