4 Reasons to Buy the Big Banks After Earnings

The large U.S. banks have all reported their third-quarter earnings, and on first glance, the numbers may not look very good. Investment banking and trading revenue is down due to global uncertainty, and banks are having a tough time growing profits in the low interest rate environment. However, these are temporary issues. A deeper look into the big banks' earnings shows that several metrics that could translate into long-term profitability are headed in the right direction. With that in mind, here are four positive trends to notice from the banking sector's third-quarter earnings.

Loan growth shows consumer confidence
Not only does making more loans lead to increased profits for the banks for obvious reasons, but it's also a good economic sign that consumers are more comfortable spending money. And loan growth is looking rather impressive among the big banks.

Wells Fargo's (WFC -0.84%) loan portfolio grew by 8% since this time last year, including an impressive 10% jump in auto originations. The bank has also done a good job of getting more business from its existing customers, with credit card penetration up to 42.9% of its banking customers, compared to 39.7% a year ago.

Bank of America (BAC -3.41%) issued 1.3 million new credit cards to U.S. consumers during the quarter and also originated 13% more mortgages. Citigroup's (C -2.94%) Citicorp (core) loan portfolio grew by 5% year over year and saw higher credit card sales. Finally, JPMorgan Chase (JPM -0.98%) grew its core loan portfolio by an impressive 15% year over year, including 4% growth in the past quarter alone.

Now, to be fair, some of this increased lending activity is likely due to the current low interest rate environment, but there are a few reasons not to worry about rising rates. First of all, as rates rise, the spread between the banks' cost of borrowing and the interest they can charge (their profit) widens. And, loan demand might not fall by as much as you'd think -- rising rates generally signal an improving economy, meaning even more confidence to borrow and spend.

Asset quality keeps improving, and banks are more financially strong
So, lending is strong and deposits are growing. This is even better when you consider that credit quality is improving at the same time.

Wells Fargo reported that its volume of non-accrual loans dropped by 14% year over year, and that the bank's overall charge-off rate dropped as well. Bank of America saw similar results, with net charge-offs (NCO) down 11%. And, JPMorgan's trend of lower NCOs continued in both credit cards and mortgage banking.

Source: JPMorgan Chase. 

As a result of the better credit quality and other positive industry trends, banks have been able to build up their capital and liquidity. In fact, Bank of America reported record capital and liquidity levels, and Citigroup's capital and leverage ratios significantly improved over the past year.

Source: Citigroup.

Additionally, Citigroup continues to shed unwanted assets. While the $110 billion worth of legacy assets in the Citi Holdings division is still a substantial amount, it is down 20% over the past year, and Citigroup has steadily disposed of its assets quarter after quarter for several years now.

Focus on efficiency is paying off
All of the big banks are doing a good job of increasing their efficiency. JPMorgan Chase has done a particularly good job of this, with 142 fewer branches than a year ago, and 10,000 fewer employees than at the start of 2015. As a result, noninterest expenses fell by 3% year over year despite higher legal costs, and the bank produced a 12% return on equity (ROE) -- an improvement from 10% a year ago.

The other big banks are operating more efficiently as well. Bank of America's ROA and ROE of 0.82% and 7%, respectively, are rather low for the industry, but they are much better than the numbers B of A was producing last year. Wells Fargo's efficiency ratio improved from 58.5% in the second quarter to 56.7% in the third, which helped the bank trim noninterest expenses even though revenue grew by 3%. And, Citicorp (Citigroup's core business) operated at an even more impressive 55% ratio and has produced a ROA of 0.99% year to date -- just below the 1% benchmark.

Mobile banking is catching on
Banks have been investing a lot of resources to develop mobile banking apps, and for good reason. When consumers use mobile banking to handle deposits, transfers, and other transactions, it saves the bank money.

For example, when you use a mobile app to deposit a check, the bank saves money on paper costs and doesn't have to pay an employee to process the check. If enough people adopt mobile banking, banks will need fewer physical branches and ATMs, which translates to real, permanent expense reductions. In fact, Bank of America CEO Brian Moynihan recently said it costs the bank 90% less to handle a transaction through a mobile app than at a branch.

Fortunately, it looks like mobile banking is heading in the right direction. Three out of the big four banks reported mobile user growth:

Citigroup did not include mobile growth in its earnings release, but it did announce that it is creating an entirely new unit, Citi FinTech, dedicated to designing a "radically simple, connected mobile banking solution."

The Foolish bottom line
It's natural for banks to produce mediocre results when the stock market is in correction (as it was for much of the third quarter), global markets are in turmoil, and interest rates are low. However, since we're focused on these stocks as long-term investments, we need to look past these temporary issues and focus on things that could help grow the banks' future profits. And, when it comes to the metrics that matter to long-term investors, the third-quarter earnings from the big banks looked pretty good.