Wall Street’s biggest banks report their earnings this week against a backdrop of rising optimism. Since the start of October, bank stocks have risen almost 9 per cent, compared with a 3 per cent gain in the wider market, a rare respite from the deep underperformance that has dogged the sector during the Covid-19 pandemic.
The explanation has much to do with interest rates. The yield on the 10-year US Treasury has risen by a tenth of a percentage point this month, which is a lot, given that it started October under 0.7 per cent. The Federal Reserve has signalled its determination to keep short-term rates at zero, so signs of life in the 10-year yield mean a steepening yield curve and wider profit margins for banks, which borrow short and lend long.
The question now is whether the big US banks’ earnings reports, which begin Tuesday, will build on the market momentum, or kill it. Below are five things investors will be looking for.
The reflation trade
As President Donald Trump and the Republicans have slipped in the polls in recent weeks, there has been chatter that a Democratic White House and Congress might help banks’ prospects — despite the party’s more heavy-handed attitude towards financial regulation.
According to Scott Siefers of Piper Sandler, the consensus “used to be that Trump and the Republicans would be best for banks, but there is an emerging view that a Democratic sweep would mean more stimulus for longer, which would help banks’ credit profile, and would have ramifications for inflation, which would push up [long] rates”.
Investors will be listening for insight into how banks are positioned for the possibility of an inflationary environment in 2021.
Trading bonanza, part II
Banks have said the third quarter was good for capital markets, but not a repeat of the blowout that they enjoyed in the second quarter, when fixed-income revenues doubled across the big five banks.
In mid-September, Jenn Piepszak, JPMorgan Chase’s chief financial officer, said her bank was on track for a 20 per cent increase in third-quarter revenues versus a year earlier.
Brian Moynihan, Bank of America’s chief executive, said third-quarter trading revenues would be up just 5 per cent, while Mark Mason, Citigroup’s chief financial officer, predicted a low double-digit percentage increase. But a strong end to the quarter on trading floors could provide upside surprises.
Wells Fargo’s cost cuts
Charlie Scharf, Wells Fargo’s boss, has been in the job for a year now, and during that time he has commented repeatedly on his bank’s bloated cost structure.
Investors are itching for details on how much cost will come out, and when. But a person familiar with Wells Fargo’s approach said it was unlikely to announce a big-bang jobs reduction programme or cost-cutting target on its earnings call.
“It’s a multiyear process,” he said, likening it to the years of cuts BofA made over the financial crisis.
Credit quality “numbers have been tracking much better than you would have thought” even three months ago, said Chris Kotowski, bank analyst at Oppenheimer & Co. As a result, “there has been a real change in investor sentiment”, according to Mr Siefers.
Several bank executives have suggested that, after adding tens of billions to loan loss reserves in the first and second quarters, relatively little additional money will be put aside in the third quarter.
If the numbers do come in low, investors will be free to contemplate the day when banks might begin to release reserves, giving profits a boost.
Return of the credit card
One of the most striking — and, in many ways, welcome — aspects of the coronavirus recession is that US consumers have largely put away their credit cards. Credit card spending was down close to 40 per cent in April and has been slow to recover.
This kept defaults down, but “it’s been a big negative impact on net interest income”, Mr Kotowski said, pointing out that credit card loans on bank balance sheets have fallen 12 per cent since April.
If consumers started taking their cards out again in the third quarter, that is good news for the banks, so long as it is high-quality borrowers doing the spending.