By Nicholas Larsen, International Banker
With loan loss provisions (LLPs) tied to the pandemic failing to materialise, the banking sector in the United States has been posting record financial results recently. And with only a few weeks of 2021 remaining, it would seem that American banks are on course for possibly their best year ever.
October saw US banks report another stellar round of earnings for the third quarter, leading many to conclude that 2021 will be a record year for the banking sector. The earnings this year have followed a decidedly subdued 2020, as banks spent much of last year extending loan loss reserves (LLRs) in response to the impact of the coronavirus pandemic. But with the US economy firmly on the road to recovery this year and with the aid of a substantial government stimulus programme, loan-repayment holidays and other federal support programmes, banks have been able to free up much of those reserves—$6 billion in total for the four biggest banks—which has played a major role in propelling their profits to all-time highs.
Four of the country’s biggest banks—JPMorgan Chase, Bank of America, Wells Fargo and Citigroup—all comfortably beat analyst expectations for third-quarter earnings, as the strong economic rebound from the pandemic continued virtually unabated, despite lingering concerns over a number of issues, including creeping inflation, pronounced supply-chain challenges and further potential flare-ups of COVID-19. The four lenders reported a combined profit of $28.7 billion for the quarter. Bank of America, for instance, saw its net income rise by a whopping 58 percent versus 2020’s third quarter to hit $7.7 billion, while revenue, net of interest expense, surged by 12 percent to reach $22.8 billion. Goldman Sachs also confirmed that it is on course for record profits this year, as the US lender posted total revenues of $13.6 billion for the quarter, a hefty 26-percent more than a year earlier. Total net income registered at $5.4 billion, moreover, well above analyst expectations of $3.7 billion and a whopping 59 percent higher than 2020’s third-quarter figure.
Much of the bullish sentiment surrounding the banking sector is also reflected in the surge in bank stocks consistently observed across the year. Indeed, the Dow Jones U.S. Banks Index (^DJUSBK), which “is designed to measure the performance of US companies in the banks’ sector”, soared by almost 44 percent this year up to early November.
Such phenomenal growth has prompted several analysts over the last few months to predict a record year in store for the US banking sector. Christopher McGratty, managing director and head of US bank research for KBW (Keefe, Bruyette & Woods), raised his investment rating for the entire US banking sector to “overweight” in early September based on stronger loan growth, higher interest rates and more opportunities for capital deployment. “If you listen to what the banks have said, they’ve actually been increasingly more optimistic about a second-half turn. Now, I don’t think it’s going to be a massive acceleration,” McGratty told S&P Global Market Intelligence. “But I think we’re calling it kind of an inflection point. And if that happens, all the factors … work in concert to help support positive earnings revisions for the group.”
Tim Adams, chief executive of the Institute of International Finance (IIF), told CNBC in late May that it was likely that banks would achieve “record-level earnings” this year. And Deutsche Bank analyst Matt O’Connor was similarly optimistic in a September 30th note to clients. “We see it in the bank stocks, and I think it’ll continue to reflect those underlying, really strong fundamentals for at least the rest of this year…. It’s hard to be too negative on the banks given a generally favourable macroeconomic outlook among most and the prospect for higher rates and faster loan growth.”
So, other than the release of reserves, what has been behind US banking’s spectacular performance this year? A handful of key factors, it would seem. Perhaps the most obvious is the growth associated with the US economic recovery, which has boosted spending across the country. “The health of the economy is the key driver for banks,” Bloomberg Intelligence analyst Alison Williams told The New York Times just prior to the results. “The consumer is out there spending—similarly, businesses look healthy.”
As such, credit- and debit-card spending notably drove growth for many banks in the third quarter, with issuers seeking to capitalise on improving economic conditions by introducing new card products, offers, flexible payment schemes and rewards. For example, the 21-percent growth in combined credit-and-debit-card spending by Bank of America’s customers particularly helped boost the bank’s earnings. “We reported strong results as the economy continued to improve and our businesses regained the organic customer growth momentum we saw before the pandemic,” noted the bank’s chairman and chief executive officer, Brian Moynihan. Card spending was also crucial in driving JPMorgan’s recent success. The biggest US bank’s third-quarter profit jumped by 24 percent over the year, with combined debit-and-credit-card spending up 26 percent. And card-purchase sales volumes within Citi’s global consumer-banking segment climbed 20 percent year-on-year, versus a 10-percent decline during the same quarter last year.
Record fees being generated from investment banking also go a long way towards explaining US banks’ stellar performance this year; a frenzy of mergers and acquisitions (M&A) deals as well as heightened private-equity and initial public offering (IPO) activity—the craze of fundraising via special-purpose acquisition vehicles and companies (SPACs) certainly helped here—drove earnings to new peaks. Indeed, according to global banking data from Refinitiv covering the first nine months of the year, fees for M&A and equity capital markets (ECMs) hit their highest levels since records began two decades ago, reaching a massive $60.6 billion through the end of September. And to capitalise on low rates, lenders also took in $52 billion in underwriting loan and debt offerings during this period.
Refinitiv also calculated that five American banks, led by JPMorgan Chase and Goldman Sachs, accounted for the greatest share of the $112.6 billion in investment-banking fees earned for the nine months, with the two Wall Street giants earning a combined $18 billion. “Companies are more experienced with M&A as a tool,” Blair Effron, co-founder of Centerview Partners, one of the largest boutique investment banks, told the Financial Times in early October. “Given the rapidity of disruption, for a lot of companies, it’s easier and faster to think about buying.”
As for the third quarter, Goldman Sachs enjoyed strong investment-banking revenues of $3.7 billion, whilst revenues at JPMorgan and Morgan Stanley surged by 52 percent to $3.3 billion and by 67 percent to $2.9 billion, respectively. “The capital markets businesses are actually quite a bit stronger than I think we expected coming in,” according to Piper Sandler’s managing director, Jeff Harte, who, commenting on the banks’ third-quarter earnings, principally attributed the sector’s outperformance to investment banking.
But will the good times last for much longer? As far as the banks themselves are concerned, the projections range from decidedly positive to cautiously optimistic. “The outlook for the economy is promising,” Charles Scharf, Wells Fargo’s chief executive, recently said, whilst also noting that the bank’s customers are keen to spend and that the median customer deposit balance is higher than pre-pandemic levels. “Consumers’ financial condition remains strong with leverage at its lowest level in 45 years and the debt burden below its long-term average. Companies are also strong as well.” Paul Donofrio, Bank of America’s chief financial officer, was similarly upbeat about the future. “If you look at the economy, it’s improving, people are spending more, and businesses are going to have to start investing,” he said, following the release of the bank’s third-quarter results.
Banks have also embarked on a massive bond-sale binge since their strong third-quarter earnings performance, adding to the already significant volumes they have issued during the year. Some banks, such as JPMorgan, have done so to alleviate impending regulatory pressure, whilst others have issued debt to capitalise on market conditions prior to the Federal Reserve (the Fed) lifting the restrictions it placed on banks last year. By late October, the six largest US banks had issued $314 billion of bonds for the year, according to Dealogic, thus representing an enormous cash grab for the sector. JPMorgan recently sold $3 billion worth of bonds in the US investment-grade market, while Citigroup had earlier accessed the market with a $4-billion issuance. Much of the interest has also seemingly resulted from the anticipation of the Federal Reserve’s announcement in early November that it would trim its quantitative-easing programme.
But with banks having already released 60 percent of their loan loss reserves (LLRs), as per recent data from Goldman Sachs, any future quarterly earnings will capture much smaller releases. And while profits are undoubtedly impressive, US banks are surely cognisant of certain frailties that could lead to a more subdued end to the year. “Of all the large banks, JPMorgan remains the most susceptible to regulatory-driven issuance pressures as balance sheet growth drives higher leverage exposure, in turn driving issuance needs under long-term debt requirements,” Jesse Rosenthal, a senior analyst at CreditSights, recently noted, adding that long-term, debt-driven pressures will mean that the US’ biggest bank is a regular net issuer for the “foreseeable future”; in turn, this could be a consistent weight on performance going forward.
Investment banking may also experience a slowdown in activity sooner than later. Indeed, much of the frenzied dealmaking throughout the year was perhaps in anticipation of increasingly challenging approaching headwinds as the administration of President Joe Biden looks set to raise capital-gains taxes. The federal government has also expressed concern over M&A activity in both the tech and banking sectors, which it perceives as anti-competitive. That said, some believe this buoyant pace of dealmaking will remain for the long term. “I remain optimistic,” Goldman Sachs’ chief executive officer, David Solomon, said on a call with analysts. “Activity levels remain high, particularly in investment banking.”
“You’re seeing many companies across industries re-examining their business models coming out of the pandemic,” Barclays analyst Jason Goldberg recently told The New York Times. “Historically, the biggest potential disruption to M&A has been market volatility, so that’s certainly something we’re keeping an eye on. But in the near term, it sounds like activity should be elevated globally.”
Could inflation—and subsequent monetary tightening—also prove to be a major spoiler for US banks? After all, annual prices rose by a 30-year high of 4.4 percent in September. Plus, the Federal Reserve has now revealed that it will slow its rate of asset purchases from November onwards, although the central bank’s chair, Jerome Powell, stressed that it is still not time to raise interest rates, explaining that “there is still ground to cover to reach maximum employment both in terms of employment and terms of participation”. According to Goldman’s Solomon, accelerating prices and the debate surrounding monetary policy could well temper the outlook for the bank, alongside a potential resurgence in COVID-19 cases and “complicated” trade relations between the United States and China. “Taken together, these items have the potential to be a headwind to growth,” Solomon warned following Goldman’s third-quarter earnings release.
But it remains unlikely that the Federal Reserve will increase interest rates until well into next year at the earliest. “Inflation is front and center as an issue and will be for the next six to 12 months, easily, but that alone is not going to dictate Fed action,” Greg McBride, chief financial analyst at Bankrate.com, told NBC News following the Fed’s early-November rate-setting meeting. “Economic growth, the labor market and even geopolitical concerns could very likely come into play.” According to the IIF’s Tim Adams, moreover, rates are likely to stay at the current lower bound for some time yet. “I think they’re going to run this economy hot. I think they’re going to run it hot for a very long time, and they’re going to wait and see inflation and how sustained inflationary pressures are rather than just transitory, which is what we’re seeing now,” he said.
Nonetheless, banks remain decidedly wary of any potential hawkishness over the coming months. “It’s good to be watchful.… There’s certainly nothing that suggests there are any issues, but markets are bouncing a little bit,” Morgan Stanley’s chief executive officer, James Gorman, recently acknowledged. “And over the next 18 months, we’ll see more of that as the Fed starts to move.”
But even if monetary tightening is implemented in the near future, it is unlikely to prevent 2021 from going down as a vintage year for US banks, given the bumper profits they have already realised thus far. “We don’t know the future any better than you do,” JPMorgan’s chief executive officer, Jamie Dimon, recently admitted. “What we really want is good growth right now. These are great numbers. By the end of 2022, people are forecasting 4 percent unemployment, wages are going up, jobs are plentiful. Getting out of COVID, we should all be thanking our lucky stars.”