US banks are reaping the rewards of interest rates

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The pervasive tension between traders and deposit takers on Wall Street has never been felt more keenly than during the third quarter earnings season, as banks had time over the summer to digest the Emerging evidence of persistent inflation in the US and the rising interest rates needed to combat it.

Broadly speaking, it’s the investment bankers who are nervously awaiting the awkward meeting with HR, as business dries up and many are now considered surplus to requirements (US banks are notoriously insensitive to long-term employees). date). Custodial banks are generally in a better position to earn larger margins on large savings piles, though even here nervousness about the direction of a falling US housing market and its impact on balance sheets is palpable. In short, UK investors who might view the sector as a game of US interest rate hikes can thank the strong dollar as a deterrent to investing while the outlook is still very hazy.

Citigroup’s mutant hybrid

The most interesting aspect of from Citigroup (US: C) in recent months was the large investment made by Warren Buffett in June, who bought $2.5bn (£2.2bn) worth of shares at $44 per share. At current prices, Sage of Omaha’s return on investment is flat, excluding dividends. This could be considered a success given that net profit in the quarter fell 25% to $3.5 billion, on revenue of $18.5 billion, as the bank saw lower fees than she receives from investment banking and wealth management, which generates interest the company could not compensate.

A combination of lower fees, investment banking, and a higher cost of capital drove operational gearing back in the quarter – although institutional segment revenue was down only 5% , year-over-year, net income fell 30%, which was the main contributor to the 25% drop in pretax profits to $4.4 billion. The company is also trying to manage its exit from Russia, which it said it would complete by the first quarter of next year.

Citi’s net interest margin was short at 2.31% for the quarter, with analysts expecting a flat year-end for this key metric. The reasons are not hard to understand: the bank experienced cost inflation of 8% for the quarter, while it still oversees the hashing and change of its operations which is Citigroup’s flagship business. It’s true that the shares are currently trading at just over half the tangible book value of $80 per share, but many are still wondering what Berkshire Hathaway (US: BRK.A) seen in Citigroup to justify its investment. Always too big, too likely to miss targets, and always ready to stir up a scandal.

JPM’s Interest Rate Premium

The general theme of the quarter is that specialized and targeted institutions seem to be doing better than sprawling generalists. JPMorganChase (US:JPM) has its share of inactive investment bankers with no deals to execute and a cost base that grew exponentially in the quarter – that figure rose 12% to $19.2 billion, primarily due to compensation Staff. However, as with other banks, the Wolf of Wall Street parties are over.

Crucially, the austerity mood around the results reflects the fact that the bank is taking the pulse of American business, through its many loans to small and medium-sized businesses, and the outlook here is uncertain to say the least. This resulted in the accumulation of risk capital to offset the impact of defaults. Reserve capital increased by $808 million in the quarter, compared to a profit of $2.1 billion in 2021, as pandemic-related default risks decreased and capital was released. JPMorgan’s total default reserve now stands at $1.5 billion, which also reflects lending growth in its wholesale market segment.

There was a clear sense in the results that the deposit arm of the bank is now in charge as the Federal Reserve looks set to relentlessly raise interest rates to calm stubborn inflation. For example, net interest income of $17.6 billion, 34% more than last year, which came precisely from the widening of margins.

BoA: substantial deposits

The sense of the brewing storm was also apparent to Bank of America (US: BAC) the bank posted a strong increase in deposits, which rose 7% for the quarter as businesses and consumers put money aside to take advantage of better savings rates. The rise means the BoA now has over $1 trillion in cash deposits, with the retail banking segment fueling the results with net income of $3.1 billion. That was significant in a quarter where the disappearance of investment banking fees led to a 46% drop in profit for the Global Banking division.

In fact, Bank of America may raise a glass to the Federal Reserve for its hawkish stance on rates as net interest margin jumped to 2.06% from 1.68% in the same period of 2021. in other words, basic consumer banking, which has historically been more profitable than in the UK due to its plethora of fees, has become structurally more profitable, with each loan and deposit now earning far higher returns.

However, it’s important to note that Bank of America is also provisioning for a possible wave of bad debt, with reserves up $1.5 billion in the quarter. The housing market in the United States is certainly deflating, even if the protective measures put in place after the financial crisis have seen fewer defaults on mortgages, overall, while banks themselves are much better capitalized.

Wells Fargo is racking up trouble

Similar to the scale of Bank of America but with a much stronger emphasis on the main street, Wells Fargo’s (US: WFC) quarter reflects its strong depositor base – over £1.4 billion in customer deposits, combined with its ubiquity across most of Central America west of the Mississippi. Wells is also famous for the Warren Buffett investment that Buffett swore he would never sell, until he sold it. Results were marred somewhat by a $2 billion adjustment charge for historical litigation and regulatory fines to leave net income at $3.5 billion, but Wells was still able to increase the dividend by 20% .

As with all other banks, this has contributed to the fact that interest rate hikes have significantly increased the bank’s net interest margin (2.83%, compared to 2.39% in 2021), which has generated a degree of operating debt based on the rate of 2% increase in the total loan portfolio to 945 billion dollars. Unsurprisingly, the rate of loan growth slowed over the past nine months as the US housing market began to falter. Wells is generally seen as a reliable investment, although the sudden appearance of $2 billion in regularization hurt sentiment.

The poor princes of Wall Street

It hasn’t been a memorable year so far for either of Wall Street’s investment banking giants. Morgan Stanley (US: MS) and Goldman Sachs (US: GS), who both seemed to be in competition to determine which will perform worse this year. Generally, Goldman Sach’s desire to be first in all things meant that its 44% drop in net profit was considerably more impressive than the 29% posted by Morgan Stanley for the quarter.

The cause is not difficult to understand – the lack of deals for IPOs and fundraising – which had peaked just after the end of the pandemic, collapsed, which amounts to a deprivation oxygen for an investment bank. The bank also reported another management change with Goldman chief executive David Solomon that ended the bank’s foray into retail banking.

Goldman began taking deposits in the aftermath of the financial crisis as a means of accessing guarantees such as the Federal Deposit Insurance Corporation, which, along with a large cash boost from (who else?) Berkshire Hathaway, contributed stabilize the bank during the financial crisis. . Moving away from the retail market, where it was a tiny player, and focusing on wealth management looks like an attempt to go back to basics for Goldman and refocus the business on just three business units, with a commercial bank and merged investment. division.

It’s not hard to see why wealth management appeals to investment banks. Morgan Stanley’s third quarter showed how a well-run wealth management business can generate higher margins by taking fees to manage other people’s money. The division generated reported margins of 27%, based on inflow of $65 billion in net new assets on a fixed cost basis.

Overall, it was a mixed season for US banks. Their British brethren can only envy their fat margins, but the combination of a possible economic slowdown and an increase in bad debts could quickly cloud the outlook. However, if employment remains stable, the medium-term outlook is reasonably positive for the sector, as loan growth and rising interest rates have combined to widen margins for everyone. Not quite treble all around, but close.

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