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Dick Bove explains why JPMorgan and Citi sold off: They failed some important tests

Key Points
  • JPMorgan Chase and Citigroup failed to deliver on a number of fundamental areas such as loan growth and loan quality, according to Vertical Group's equity research analyst Dick Bove
  • The two banks reported better-than-expected quarterly earnings, but investors sold down both stocks
How healthy are US banks?

JPMorgan Chase and Citigroup failed to deliver on a number of fundamental areas even though they turned in better-than-expected quarterly earnings, one analyst said after investors sold down the two banking stocks.

Speaking to CNBC's "The Rundown" on Friday, Vertical Group's equity research analyst Dick Bove listed the three areas to look for in any bank earnings: an expansion in loan book, improvement in loan quality and margins that are inching up.

"Citigroup failed on all three of those tests, JPMorgan failed on two of them," Bove said.

"Both companies were unable to increase their loan volume in any meaningful way — they were up maybe 2 percent year-over-year. Both companies saw an erosion of the quality of their loan portfolios … and one of the two firms, Citigroup, was unable to increase its margins despite the fact that interest rates have been up by some 100 basis points over the last two years," he added.

Shares of the two U.S. banking giants closed in the red even as both their quarterly results, released Thursday, beat Wall Street estimates.

JPMorgan's earnings per share came in at $1.76 versus the estimated $1.65, while its revenue of $26.2 billion topped the projected $25.23 billion. Over at Citigroup, earnings per share of $1.42 also beat the $1.32 forecast, while revenue was $18.173 billion, compared to the $17.896 billion expected.

Investors seemed to focus on the negatives instead: JPMorgan's fixed income trading revenue tumbled 27 percent year-over-year to $3.16 billion, while that of Citigroup was down 16 percent to $2.877 billion.

Both banks also set aside more money for credit card losses.

"I think it's part of the normal credit cycle, credit losses have been too low and they're going up," Bove said. "There's also been an erosion in credit quality in consumers and that erosion is related to subprime lending."

That may add uncertainty about the prospects of banks at a time when commercial loan growth is also slowing, analysts said.

"Loan growth remains challenged for the bank sector as commercial loan growth has been held back by policy uncertainty as well as other funding options available to companies through the capital markets," CreditSights analysts wrote in a note.

Is the IMF wrong about bank profitability?

The health of banks once again came under the limelight after the International Monetary Fund said Wednesday in a report that nine of the world's largest financial institutions could struggle with profitability in the years ahead. Citigroup was one of the nine banks identified.

The IMF also warned that "problems in even a single" one of the banks "could generate systemic stress."

But some analysts are optimistic. Bill Stone, global chief investment strategist at PNC Asset Management Group, said on CNBC's "Street Signs" that both JPMorgan and Citigroup did "pretty good."

"Why did they sell off?" Stone asked. "I think financials have been on fire, they've been the best-performing sector over the past 30 days so I think there's a bit of 'sell on the news' since we've enjoyed all before the news."