Weekly Brief: US Banks Are Like Kids In A Candy Store

Weekly Brief: US Banks Are Like Kids In A Candy Store

over 2 years ago3 mins

America’s big banks are like kids in a candy store: they’ve been profiting from the IPO boom, they’re benefiting from shifts in inflation, and they’ve been given the all-clear to start increasing shareholder payouts again.

🕰 Recap

  • Banks have been reaping massive fees from the booming IPO market.
  • There are promising signs for their lending businesses too: shifting inflation expectations have widened the gap between short- and long-term interest rates
  • To top it all off, US banks finally got the green light to increase their dividends and resume share buybacks this week

✍️ Connecting The Dots

In case you haven’t heard, the initial public offering (IPO) market is in full swing: the amount of cash raised this year is expected to top 2007’s record of $420 billion. That’s working out great for investment banks, which take a cut of the proceeds of listings they help organize: record hauls for IPO-ing companies have led to record bank profits.

But that’s not the only tailwind blowing in banks’ favor at the moment: the difference between short-term interest rates and long-term bond yields has been widening this year. US inflation hitting its highest level since 2008 last month sent long-term government bond prices down (and their yields up): bonds’ fixed future payouts are worth less if the prices of goods and services are ticking higher. But the US Federal Reserve (the Fed) insists that this inflation increase is just a blip – and it’s therefore kept short-term interest rates at record lows.

This widening gap between short-term interest rates and long-term bond yields is good news for banks’ lending businesses. See, the main way banks make money is by charging borrowers more than it costs the banks themselves to borrow. They do that by borrowing money at cheap short-term interest rates (via customer deposits, for example), and then lending that money out at higher long-term rates (in the form of, say, 30-year mortgages). So a bank’s profit in its lending business is mostly determined by the difference between those short-term and long-term rates – with the latter determined by long-term government bond yields. A widening gap means more profit for banks from deposits and loans.

🥡 Takeaways

1. Less volatility, more stability.

The IPO boom has provided a tidy boost for banks’ investment banking businesses, but revenue in the area tends to be quite volatile. It won’t hang around forever either: IPOs are, by nature, pretty cyclical. Still, banks will be able to offset some of that drop-off with the profits from their lending businesses. What’s more, lending revenue is a lot more stable than investment banking fees, so banks’ overall revenues should become more stable too.

2. Stable revenue means stable dividends too.

At the height of the pandemic, the Fed froze banks’ share buybacks and dividends to make sure they had enough cash to see them through all the uncertainty. But passes all round in the central bank’s annual stress test means they now have the green light to start cranking up payouts again. And they haven’t hesitated: four of the biggest US banks promptly announced an extra $2 billion in quarterly dividends – a commitment these newly stable revenues should make it easy to meet.

🎯 Also On Our Radar

The number of Chinese tech IPOs dropped sharply in the second quarter: the country’s regulators have been cracking down on the sector, punishing tech companies for what they deem monopolistic practices. Chinese tech IPOs have raised just $6 billion since the start of April – down almost two thirds on the first-quarter total. And as if that wasn’t bad enough, tech listings as a proportion of all Chinese IPOs have sunk to their lowest level in two years too.

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