Four of the largest global systemically important banks (GSIBs) in the United States report their results this Friday, October 14e: Citigroup
When analyzing bank profits, it is important to remember that banks make money in three ways: net interest margin, transactions, and fees for services such as investment banking and asset Management. The most volatile of these three categories are trading income, as it is largely influenced by country risk, macroeconomics, fiscal policies, geopolitical risk, and natural disasters, which can have a significant impact on interest rates, exchange rates, commodity prices and security prices.
Right now, rising interest rates could help some banks increase their net interest margin, since they now charge more for all the new loans and credit products they approve. The median net interest margin for banks increased in the second quarter of 2022 compared to the same period in 2021. Banks should benefit from a significant increase in consumer borrowing, which, as I wrote recently, reached record levels.
However, the fear is that rising rates will make it harder for borrowers to repay their outstanding credit, especially if those credit products, like credit cards, are variable rate products. When bank earnings come out in the next two weeks, we should be looking to see what percentage of loans start to deteriorate, otherwise known as non-performing loans (NPLs). These are loans where borrowers have ninety days or more to pay. If the level of NPLs increases, we should also look to see if banks are increasing their loan loss reserves, also known as provisions; an increase in loan loss provisions means that a bank is preparing in case borrowers default. The loan loss reserve is a non-cash deduction in the income statement. Therefore, if banks err on the side of caution, we will likely see an increase in loan loss reserves to prepare for the proverbial “rainy day”, which will potentially lead to lower net profits, especially at banks. which are more dependent on net interest margin than trade and fees. At the end of the second quarter of 2022, charges are stable. Banks normally cancel loans after borrowers are more than 180 days past due.
Where banks could really be affected is in their areas of trading and fees, particularly investment banking and asset management. Asset price volatility, driven in large part by uncertainty about the Federal Reserve’s ability to control inflation and the end of Russia’s invasion of Ukraine, is expected to lower trading revenues and bank asset management fees. A decrease in mergers and acquisitions will also weigh on investment banking fees. Banks like Morgan Stanley and Goldman Sachs, whose revenues depend largely on trading income and investment banking and asset management fees, stand to suffer; they are not as diverse as JPMorgan Chase and Citigroup, which have large loan portfolios, as well as commercial and fee-earning businesses.
RC Whalen, chairman of Whalen Global Advisors, expects to “see reasonably strong earnings for smaller banks as loan yields slowly rise, but the transactional side of the house will likely be weak, hurting Morgan Stanley, Citigroup, Goldman Sachs and JPMorgan Chase.” Whalen also explained that “one name to watch in the third quarter of 2022 will be Wells Fargo & Co (WFC), which is in the process of significantly reducing its balance sheet. Improved earnings in the third quarter of 2022 could be a catalyst for this name. long underperforming As we noted in our Q2 2022 pre-earnings setup, a modest improvement in WFC’s operating efficiency, which has been in the 80% range, could be quite significant for the title. “
While potentially negative bank earnings news over the next two weeks may cause significant anxiety among market participants, it is important to remember where we are in the economic cycle and to remember to to breathe. Yes, US GDP has fallen slightly for two consecutive quarters; yet, labor markets remain tight, although not as tight as at the start of the year. While indebted corporate default rates, to which many banks are exposed, are rising, default rates are still significantly lower than they were in 2020, not to mention the financial crisis.
Importantly, due to Basel III and Dodd-Frank rules and enhanced banking supervisory exercises, US GSIBs are well capitalized and currently expected to be liquid for at least a month, even under significant stress. on credit or on the market. The four banks reporting this coming Friday all have more than double the high-quality capital required to sustain unexpected losses; Basel III Common Equity Tier I (CET
Recent articles by this author:
U.S. consumer borrowing hit record highs
The volume of defaults on leveraged loans has tripled this year
Probability of Default Increases for High Yield Bonds and Leveraged Loans