Four of the largest global systemically important banks (GSIBs) in the United States are reporting earnings this Friday, October 14thto: Citigroup
When analyzing bank earnings, it is important to remember that banks make money in three ways: net interest margin, trading and fees from services such as investment banking and asset management. The most volatile of these three categories is trading results, as they are largely influenced by country risk, macroeconomics, fiscal policy, geopolitical risk and natural disasters which can have a significant impact on interest rates, foreign exchange rates, commodity prices and security prices. .
Currently, the rising interest rate environment may help some banks increase their net interest margins, as they now charge more for any new loans and credit products they approve. Banks’ median net interest margin increased in the second quarter of 2022 compared to the same period in 2021. Banks are likely to benefit from a significant increase in consumer lending, which as I wrote recently, is at a record high.
However, the concern is that rate increases will make it harder for borrowers to repay their outstanding credit, especially if the credit product, such as a credit card, is a variable rate product. When bank earnings come out in the next two weeks, we should look to see what percentage of loans are beginning to deteriorate, otherwise known as non-performing loans (NPLs). This is a loan, which the borrower is ninety days or more in paying. If NPL levels increase, we should also see if banks increase their loan loss reserves, also known, as provisions; an increase in loan loss provisions means banks are preparing in case borrowers default. Loan loss reserves are non-cash deductions in the income statement. Therefore, if banks are prudent, we may see an increase in loan loss reserves in preparation for a ‘rainy day’, potentially leading to a decline in net income, especially in banks that rely more on net interest margins. from trade and fees. Until the end of the second quarter of 2022, the charge has stabilized. Banks usually charge a loan after the borrower exceeds 180 days in late payments.
Where banks can really make an impact is in their areas of trading and fees, particularly investment banking and asset management. Uncertainty in asset prices, largely due to uncertainty over whether the Federal Reserve can control inflation and when Russia’s invasion of Ukraine will end, is likely to push trading income and asset management fees down, at banks. A decrease in mergers and acquisitions will also affect investment banking fees. Banks such as Morgan Stanley and Goldman Sachs, whose revenues depend heavily on trading and investment banking revenues and asset management fees are likely to be affected; they are not as diversified as JPMorgan Chase and Citigroup, which have large loan books, as well as trading and fee-generating businesses.
RC Whalen, Chairman of Whalen Global Advisors, expects “to see strong earnings for smaller banks as loan yields slowly pick up, but the home transaction side is likely to be weak, hurting Morgan Stanley, Citigroup, Goldman Sachs and JPMorgan Chase.” Whalen also explained that “one name to watch in Q3 2022 is Wells Fargo & Co (WFC), which is in the process of shrinking its balance sheet dramatically. Better earnings in Q3 2022 could be a catalyst for this long-underperforming name. As we mentioned in our Q2 2022 pre-earnings preparation, a modest improvement in operating efficiency at WFC, which is in the 80% range, could be quite meaningful for the stock.”
Although in the next two weeks potentially negative news about bank earnings may cause significant anxiety among market participants, it is important to remember where we are in the economic cycle and remember to breathe. Yes, US GDP has declined slightly for two consecutive quarters; however, the labor market remains tight, although not as tight as earlier this year. Although the default rate of leveraged companies, which many banks are exposed to, is increasing, the default rate is still far below what it was in 2020, let alone during the financial crisis.
Importantly, due to Basel III and Dodd-Frank regulations and strengthened bank supervisory exercises, US GSIBs are well capitalized and currently forecast to be liquid, at least per month, despite significant credit or market stress. The four banks reporting this coming Friday are double the high-quality capital needed to sustain unexpected losses; Common Equity Basel III Tier I (CET
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