Many of the reported results of the largest U.S. banks thus far for 1Q21 have once again been supported by exceptionally strong trading and investment banking revenues, with net income further boosted by reserve releases that accelerated from the prior quarter.
Net income has generally risen for banks sequentially, but core profitability is likely to remain under modest pressure during much of 2021 relative to pre-pandemic levels, says Fitch Ratings.
Lower income is expected to be driven by pressure on spread income due to the low absolute and relative level of interest rates and weaker loan demand amid persistently elevated operating expenses. That said, with credit quality showing modest improvement and capital levels remaining strong, the overall stabilizing of operating results amid the economic recovery is expected to limit downside risk to banks and ultimately ratings.
Revenue growth in the quarter was driven by record capital market revenues from equity trading and investment banking underwriting and advisory fees. Capital markets-related fee income is expected to be supported by strong M&A pipelines and continued SPAC issuance, with outsized advisory growth at Goldman Sachs, Morgan Stanley and JPMorgan in the quarter.
Still, sales and trading revenue could decline from current levels as market volatility normalizes, and as a result and become less of a driver of revenue outperformance for banks with capital markets exposure.
The earnings tailwind from negative provisioning seen thus far for 1Q21 is expected to be an industrywide trend as quarterly results are released. Releases doubled from the prior quarter for large banks reporting 1Q21 results given improved economic forecasts.
Further reserve releases are likely if economic forecasts continue to improve from what banks are currently modeling. Moreover, releases could also be supported well into 2021 by the expectation of lower default rates as government stimulus continues to allow consumers to de-lever, as seen with the positive credit trends in the quarter.
Excluding upside from reserve releases, core, pre-provision net revenue remains below pre-pandemic levels seen in 2019 for banks without outsized capital markets businesses. Lower loan balances, which fell 5%-10% YoY for the banks reporting thus far, will likely continue to pressure earnings over the near-to-medium term.
Some banks pointed to 1Q21 as being a low point for spread revenue, given their expectation for higher long-term rates and the decision to invest excess liquidity in their respective securities books. However, loan growth, which substantially drives net interest income, is expected to remain negative amid soft commercial and consumer demand.
As expected, fees generated in the more traditional segments of U.S. banks continue to lag pre-pandemic levels, aside from mortgage origination revenue. Deposit service fees remain challenged as elevated consumers account balances result in lower overdrafts and lower revenue in consumer segments as a whole. This is gradually being offset by card revenue as consumer spend begins to pick up, particularly debit card spending.
Positively, regulatory capital ratios remained strong during the quarter. While most banks restarted share buyback programs in 1Q21 as allowed by regulators, capital levels continue to exceed pre-pandemic levels. Capital levels are expected to remain elevated during 2021 given positive capital generation and modest risk-weighted asset growth.
Furthermore, banks are expected to be measured in capital distributions 2021, particularly those banks that have outsized exposures to areas and sectors of the economy most affected by the pandemic such as commercial real estate.