Bank Earnings Good Enough to Frustrate Bears
Excerpt from Footnotes and Flashbacks: Week ended January 13, 2023
The big bank earnings numbers kicked off the flow of updated bank information for the market to absorb. JPM, C, BAC, and WFC all saw their stocks rise well ahead of the market and well ahead of the XLF (financials ETF). As I read through releases, it is hard to see signals of hard landing risk rising. After all, credit contraction, major loss provisioning actions, and the risk of weaker margins are usually part of recession risk and more downside exposure for the cycle.
We mostly look to the major bank summaries for signs of major provisioning shifts, and the market appeared relieved after Friday’s disclosure by four of the Big 6 (Goldman and Morgan Stanley report Tuesday). JPM and BAC are the big swingers in total market cap and various other metrics. Provisions are naturally higher, but more provisioning and charge-off increases come at a lag in the cycles. The banks are crucial to comfort zones, but they are also lagging indicators after the trouble sets in.
In past lives, I was never a money center or regional bank analyst, but I looked at a lot of thrifts, consumer finance, auto fincos, and leasing operators. There is always asset class exposure and signs of trouble to look for that start with borrowers or lessees showing material weakness. I routinely held out the tin cup with many others for Lehman Brothers (and the predecessor laundry list of names, e.g. Shearson Lehman Hutton, etc.,) for commercial paper lines, so I was also sensitive to what refinancing risk meant for those on the prime commercial paper cusp. We now operate in a very different world dominated by major bank holding companies and not CP-dependent brokers that can’t take funding shocks. Deposits are going to cost more, but they are not a “hot money” area in these cases. Some will migrate for higher yields from the cheapskates of the majors.
My simple version of this first wave of big bank releases is that the numbers were solid and no red flags are getting waved. I would also highlight that the biggest problem of the past often started in major areas that lacked transparency such as counterparty risks, concentration of collateral or sector exposure (e.g., sovereigns), and industry/borrower concentration risk that you could not always glean from the earnings releases. The broker-dealer domino days are over, but the not-quite-enough disclosure problem will always be an issue.
Continued loan growth may be dull and will be lower for 2023 than 2022, but the preliminary read is at least there will be growth in some categories. Consumer asset quality will “normalize,” which is the nice way banks phrase the words “decline” or “deteriorate on cyclical pressures.” It is also an admission they likely won’t be able to release reserves to pump up earnings as some did in the post-COVID period. The very solid net interest income growth of 2022 will get squeezed as banks like JPM might find more customers migrating elsewhere for more competitive deposit rates. Funding costs will rise.
The rough stretch in investment banking, underwriting, and M&A could get better with the UST curve stabilizing and inflation peaking and now declining. Value seeking in M&A seems inevitable as winners and losers on this inflation wave shake out. We could also see some of the fallen growth stocks being targets. Some have good asset potential but cannot grow on their own due to debt or because strategic optimism has faded (e.g., digital auto retail players like Carvana).