Weekly Brief: This Earnings Season Might Prove That US Banks Aren’t Unbeatable

Weekly Brief: This Earnings Season Might Prove That US Banks Aren’t Unbeatable

almost 2 years ago3 mins

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Banks kicked off first-quarter earnings season last week, and the winning streak they enjoyed throughout the pandemic might finally have come to an end.

🕰 Recap

  • US company profits are expected to have risen 5% last quarter, but banks are expected to show a 24% drop on average
  • JPMorgan Chase kicked things off with weaker-than-expected first-quarter earnings on Wednesday
  • And Goldman Sachs, Morgan Stanley, Citigroup, and Wells Fargo followed up with their results on Thursday

✍️ Connecting The Dots

Analysts are currently expecting US financial firms to report first-quarter profits that are on average 24% lower than the same time last year. Here’s why: banks built up their “reserves” – cash held as a buffer against borrowers not repaying their loans – at the peak of the pandemic, and have been releasing them ever since as the likelihood of major defaults has reduced. That move has the side effect of boosting banks’ profits. Now, though, with the global economy slowing and inflation rising to record highs, the risk that folks might not be able to repay their debts is on the upswing once again. Banks, then, have switched to building reserves back up, which has knocked profits all over again.

It’s not all bad news, mind you. The US Federal Reserve has upped the country’s interest rates once since the start of the year, and it’s likely to make bigger increases at least a couple more times in 2022. That’ll mean not only can banks increase the amount of interest they charge borrowers, but that they won’t have to up the interest they pay savers by the same amount. And the widening of that gap – the “net interest margin” – means higher profits to come.

There's a third theme likely to dominate the quarter for big banks: “capital markets” activity, which is made up of two aspects. First is the income banks earn from advising companies on mergers and acquisitions, raising equity, or issuing debt. That’ll have dropped off substantially given the heightened uncertainty this year, so investors will be looking for clues about whether delayed deals might still materialize later this year. Second is the money banks make from trading, and the key question there is whether the current uncertainty has encouraged higher activity – in turn boosting revenue – or discouraged investors from getting involved.

🥡 Takeaways

1. JPMorgan Chase shows why diversification matters.

JPMorgan Chase has a large savings and lending business, which is typically considered slow and stable. It contributed over a third of last quarter’s profit and stands to benefit from rising US interest rates later this year, which should help offset the firm’s riskier investment banking activities. And while some of the bank’s bigger advisory businesses were hit by geopolitical uncertainty, JPMorgan did brisk business helping investors trade currencies and emerging market assets amid the rise in volatility.

2. Other big US banks aren’t quite as diversified.

Goldman Sachs doesn’t have much of a savings and loans business by comparison, so its fortunes depend more on its dealmaking revenue, which dropped 36% versus the same time last year. Rival Morgan Stanley’s competing business was down 37% too, but it’s in a better position: the bank earns some 40% of its revenue from its relatively stable wealth management business. So while it doesn’t benefit as much from an upswing in trading and dealmaking, it also doesn’t lose out as much when those things slow down.

🎯 Also On Our Radar

Last week’s update from BlackRock – the world’s biggest investment manager – showed retail investors went heaviest into stock exchange-traded funds last quarter, while taking some cash out of fixed income bets. Perhaps reassuringly, that was similar to what institutional investors did – albeit with one big difference: institutions allocated more actively managed multi-asset funds.

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