The BAN Report 7/15/21
The BAN Report: Big 4 Bank Earnings / Powell Dismisses Inflation Concerns / Roubini Speaks Up / Expanded Unemployment Hurting Hiring / Calk Convicted
Big 4 Bank Earnings
The four largest banks released their earnings for the second quarter this week. All 4 beat on earnings, but revenue and loan growth were disappointing.
JP Morgan Chase
JP Morgan Chase earned $3.78 / share, exceeding estimates of $3.21 and exceeded its revenue estimate as well. Improving credit added $2.3 billion to their earnings as the $3 billion in released loan loss reserves were off-set by $734 million in charge-offs. In the prior quarter, JP Morgan released $5.2 billion in reserves. A big disappointment was trading revenue.
Trading revenue fell 30% from the year earlier period, an expected outcome after the frenzied activity in the aftermath of Federal Reserve actions to bolster markets during the early stage of the coronavirus pandemic.
Loan growth has also been tough as average loans are down 3% from the prior year, while average deposits are up 25%. It also looks as if the second quarter was particularly tough for loan growth, as the quarter-to-quarter decline was 3%.
Bank of America
The company said revenue fell 4% from a year earlier, driven by a 6% drop in net interest income because of lower interest rates. Lower trading revenue and the absence of a $704 million gain a year earlier also hit revenue, the bank said.
Bank of America’s results show the impact of falling interest rates on the industry. Banks gather deposits and extend loans; falling interest rates squeeze the margin between what they pay depositors and charge borrowers. The bank’s net interest margin of 1.61% in the quarter was 26 basis points lower than a year earlier and below the 1.67% estimate of analysts surveyed by FactSet.
CFO Paul Donofrio cited the “continued challenge of low interest rates” in the bank’s earnings release. The 10-year Treasury yield broke above 1.75% in March amid the economic comeback, hitting its highest level since the pandemic began. But the benchmark rate has pulled back to around 1.40% as of Tuesday.
A 1.61% net interest margin is pretty remarkably skinny. The ‘Q1 Quarterly Banking Profile showed 2.56% for the entire industry – the lowest ever. Moreover, B of A’s margin shrunk by 7 basis points from the prior quarter, which suggests the industry has not yet turned the corner on rates. The good news is B of A grew loans in the second quarter – the first time since early last year. They also released $1.6 billion in loan loss reserves.
The market reacted favorably to Wells Fargo’s earnings, as it beat on both earnings and revenue. Loan growth was disappointing.
Wells also reported a net interest margin — a measure of how much a bank earns from the difference between what it pays on deposits and what it takes in on loans — of 2.02% for the quarter. Analysts were expecting 2.05%, according to FactSet. Persistently low interest rates have continued to weigh on that part of the bank business.
CEO Charlie Scharf said in a press release that demand for the bank’s loans remains somewhat muted despite the economic recovery.
“Wells Fargo benefited from the continued economic recovery, strong markets that helped drive gains in our affiliated venture capital businesses, and our progress on improving efficiency, but the headwinds of low interest rates and tepid loan demand remained,” Scharf said in the earnings release. “Our top priority continues to be building an appropriate risk and control infrastructure for a company of our size and complexity and we continue to invest in additional resources and devote significant management attention to this work.”
Describing loan demand as “tepid” suggests Wells has not yet seen uptick in loan demand. Earlier this month, Wells announced it was shutting down all existing personal lines of credit, so Wells appears to be less focused on loan growth.
Citigroup had a great quarter, beating on earnings, revenue, and showing loan growth from the prior quarter.
The firm’s earnings jumped after it released reserves set aside for loan losses, resulting in a $1.1 billion benefit after $1.3 billion in charge-offs. A year ago, the bank had been forced to set aside billions for expected credit losses, resulting in an $8.2 billion credit cost.
“The pace of the global recovery is exceeding earlier expectations and with it, consumer and corporate confidence is rising,” CEO Jane Fraser said in the release. “We saw this across our businesses, as reflected in our performance in investment banking and equities as well as markedly increased spending on our credit cards. While we have to be mindful of the unevenness in the recovery globally, we are optimistic about the momentum ahead.”
Like other Wall Street rivals, Citigroup posted a sharp decline in fixed income trading revenue in the quarter. Fixed income operations generated $3.2 billion in revenue, below the $3.66 billion estimate.
But the bond trading decline, which was expected, was offset by better-than-expected results in equities and investment banking.
In the second quarter, Citigroup announced it was exiting retail operations in 13 countries outside of the US.
Overall, banks continue to benefit from releases in loan loss reserves, as credit quality improves. However, margins and loan growth continue to be tough. With higher rates on the way and an economy growing in the high single digits, one would expect the rate environment to finally turn the corner for banks and loan growth should improve. For smaller banks that saw strong PPP originations, loan growth will be especially challenging as PPP forgiveness accelerates in the second half of the year.
Powell Dismisses Inflation Concerns
Yesterday, Fed Chairman Jerome Powell acknowledged rising inflation, but gave no indication that the Fed is considering a change of policy.
Jerome H. Powell, the Federal Reserve chair, told House lawmakers on Wednesday that inflation had increased “notably” and was poised to remain higher in coming months before moderating — but he gave no indication that the recent jump in prices will spur central bankers to rush to change policy.
The Fed chair attributed rapid price gains to factors tied to the economy’s reopening from the pandemic, and indicated in response to questioning that Fed officials expected inflation to begin calming in six months or so.
Mr. Powell testified before the Financial Services Committee at a fraught moment both politically and economically, given the recent spike in inflation. The Consumer Price Index jumped 5.4 percent in June from a year earlier, the biggest increase since 2008 and a larger move than economists had expected. Price pressures appear poised to last longer than policymakers at the White House or Fed anticipated.
“Inflation has increased notably and will likely remain elevated in coming months before moderating,” Mr. Powell said in his opening remarks.
He later acknowledged that “the incoming inflation data have been higher than expected and hoped for,” but he said the gains were coming from a “small group” of goods and services directly tied to reopening.
Mr. Powell attributed the continuing pop in prices to a series of factors: temporary data quirks, supply constraints that ought to “partially reverse” and a surge in demand for services that were hit hard by the pandemic.
He said longer-run inflation expectations remained under control — which matters because inflation outlooks help shape the future path for prices. And he made it clear that if the situation got out of hand, the Fed would be prepared to react.
Given how unprecedented the economic situation has been in the past year and a half, no one really knows how this inflation story plays out. But, others are more worried, including Nouriel Roubini.
Roubini Speaks Up
Nouriel Roubini, professor of economics at New York University’s Stern School of Business, was the go-to economist in the 2008 financial crisis, earning the moniker “Dr. Doom.” He warned earlier this month how surging inflation could present a very difficult challenge to central banks.
We are thus left with the worst of both the stagflationary 1970s and the 2007-10 period. Debt ratios are much higher than in the 1970s, and a mix of loose economic policies and negative supply shocks threatens to fuel inflation rather than deflation, setting the stage for the mother of stagflationary debt crises over the next few years.
For now, loose monetary and fiscal policies will continue to fuel asset and credit bubbles, propelling a slow-motion train wreck. The warning signs are already apparent in today’s high price-to-earnings ratios, low equity risk premia, inflated housing and tech assets, and the irrational exuberance surrounding special purpose acquisition companies, the crypto sector, high-yield corporate debt, collateralized loan obligations, private equity, meme stocks, and runaway retail day trading. At some point, this boom will culminate in a Minsky moment (a sudden loss of confidence), and tighter monetary policies will trigger a bust and crash.
Making matters worse, central banks have effectively lost their independence because they have been given little choice but to monetize massive fiscal deficits to forestall a debt crisis. With both public and private debts having soared, they are in a debt trap. As inflation rises over the next few years, central banks will face a dilemma. If they start phasing out unconventional policies and raising policy rates to fight inflation, they will risk triggering a massive debt crisis and severe recession; but if they maintain a loose monetary policy, they will risk double-digit inflation – and deep stagflation when the next negative supply shocks emerge.
Mr. Roubini makes a great point – today’s high debt levels make the cure to inflation (higher rates) more painful than it would be otherwise. The Fed argues that much of the inflation is temporary and will ease when COVID-induced frictions wane.
His views on Bitcoin and cryptocurrencies are very interesting. For some reason, the CoinGeek Zurich invited him to give a keynote speech and he just eviscerated Bitcoin, arguing that it has negative value. This often-hilarious speech is worth watching.
Expanded Unemployment Hurting Hiring
For months, there’s been anecdotal evidence that employers are having difficulty hiring low-wage workers due to the more generous unemployment insurance. A poll this week provided empirical evidence of this unique employment problem.
About 1.8 million out-of-work Americans have turned down jobs because of the generosity of unemployment insurance benefits, according to Morning Consult poll results released Wednesday.
Why it matters: U.S. businesses have been wrestling with labor supply shortages as folks capable of working have opted not to work for a variety of reasons.
- One of the more politically controversial reasons has been the availability of unemployment insurance benefits, in particular emergency provisions that were introduced because of the COVID-19 pandemic.
- Indeed, 26 states opted to cut emergency benefits early with the intention of incentivizing people to take open jobs.
By the numbers: Morning Consult surveyed 5,000 U.S. adults from June 22-25, 2021.
- Of those actively collecting unemployment benefits, 29% said they turned down job offers during the pandemic. In response to a follow-up question, 45% of that group said they turned down jobs specifically because of the generosity of the benefits.
- Extrapolating from the 14.1 million adults collecting benefits as of June 19, Morning Consult concluded that 1.8 million people turned down job offers because of the benefits.
Anyone who has traveled recently can see how many employers are operating with skeleton crews despite strong demand.
Chicago Banker Stephen Calk was convicted this week of bribery after making loans to Paul Manafort, in exchange for a possible Trump cabinet post.
A federal jury in Manhattan convicted a former bank executive on charges that he helped arrange $16 million in loans to former Trump campaign chairman Paul Manafort, in exchange for help getting a high-level job in the Trump administration.
Stephen M. Calk, the founder and former chairman of the Federal Savings Bank in Chicago, was found guilty on both counts he faced: financial-institution bribery and conspiracy to commit financial-institution bribery. Federal prosecutors said Mr. Calk pushed the bank to approve the loans to Mr. Manafort, despite multiple red flags, because he hoped to be named secretary of the Army.
Mr. Calk’s lawyer, Paul Schoeman, argued at trial that Mr. Calk thought he was making profitable loans—which were unanimously approved by the bank’s loan committee—and said Mr. Calk wasn’t acting in bad faith. Instead, Mr. Schoeman said, Mr. Manafort and one of the bank’s loan officers were defrauding the bank Mr. Calk had dedicated his life to building.
The bank agreed, and Mr. Manafort asked Mr. Calk to join the campaign’s economic advisory council. Bank underwriters soon uncovered trouble with Mr. Manafort: his credit score had plummeted, he had no income in 2016, and he had a $300,000 credit card bill. He was in default, on the outs with the Trump team, and facing foreclosure.
Prosecutors and several witnesses said at trial that nobody at the bank supported the loan—which had grown to $9.5 million—aside from Mr. Calk and Mr. Raico, who stood to earn a commission. Mr. Calk’s lawyers said bank employees and executives didn’t tell Mr. Calk about their concerns.
This wasn’t an easy case for the government to prove, but making a loan in excess of the bank’s lending limit to a borrower with financial problems was such an outlier that the government obtained a conviction without a clear quid pro quo. It does suggest that bank should be extremely careful about making exceptions on loans to politically-connected borrowers.