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Posted July 19, 2022

Sean Ring

By Sean Ring

The Bankers’ Beatings Begin

  • All of America’s banks’ profits have been hit hard.
  • As the Fed tightens, banks should make higher net interest margins.
  • But even as trading has thrived, investment banking is hurting.

Happy Tuesday.

As I was driving from Newark Airport to the Big Apple, I noticed whoever put Hudson Yards up has blocked the view of the Empire State Building from the Jersey side.

Unforgivable.

As you spin down to the Lincoln Tunnel entrance, you used to get a perfect view of the Empire State Building, right across the Hudson.

Now that monstrosity of a construction project completely blocks out New York’s best skyscraper (apologies, my dear Chrysler Building).

Seriously, the whole place has fallen apart since I left on that fateful October 3rd of 1999.

Still, it’s ok to be back.  I’ve not been to the US for three-and-a-half years.

NYC’s vibe is much different from the days I’d frolicked around in the late 90s.

Heck, Rudy made the place so safe I could keep my wallet in my back pocket.

This time, I left my Rolex at home in favor of my Apple watch.

No one is going to steal one of those

I’m teaching here for the next month, and I’m trying to get enthusiastic about it.

Not that teaching isn’t fun.

It’s just that we’re in the midst of a mess - and now the banks have fallen headlong into it.

Let me explain.

Bank Earnings Have Been Pummeled

Get a load of these numbers:

  • Goldman Sachs’s second-quarter profit fell to $2.9 billion from $5.5 billion a year ago.  That’s down 47% quarter on quarter.  Revenue fell 23% to $11.9 billion.

     

  • Bank of America’s profit fell 32% to $6.2 billion, and revenue rose 6% to $22.7 billion.

     

  • JPMorgan Chase’s earnings fell 28% after building reserves for bad loans.  The bank suspended buybacks.

     

  • At Morgan Stanley, profit dropped 29% to $2.5 billion, or $1.39 per share, from $3.51 billion, or $1.85 per share, a year ago. Revenue fell 11% to $13.13 billion from $14.8 billion, driven by the steep 55% decline in investment banking revenue.

     

  • Wells Fargo’s second-quarter net income declined to $3.12 billion, or 74 cents a share, from $6.04 billion, or $1.38 a share in the year-ago quarter.  Analysts were expecting 80 cents a share.

     

  • Of the Big 6, only Citigroup outperformed when profits fell “only” 27%.   Citi shares rose 11% after the bank said its second-quarter earnings fell to $4.55 billion, or $2.19 a share, from $6.19 billion, or $2.85 a share, in the year-ago quarter.

Clearly, this isn’t an isolated happening.

It’s not a Credit Suisse-like tragedy of errors.

This is a sector-wide whooping.

And there are some compelling reasons for it.

Why Is This Happening?

First, let’s have a look at the year-to-date returns on our Big six banks:

No, those aren’t the latest crypto results.

Though you can be forgiven for thinking so.

Really, this has been going on since the market started turning down in November 2021.

The question is, ‘Why?”

Higher Inflation

Last Thursday, the Producer Price Index shot up 11.3% year-on-year, just off the record number set in March.

I don’t care what the mainstream economists write about inflation calming down.

If your wholesale prices are going up that fast, some of that will get passed onto the consumer.

As the CPI was “only” 9.1% year-on-year, that means producers are currently shielding consumers from some of that inflation.

That means more consumer price increases may come down the pike.

The inflation story isn’t over yet.

Higher Interest Rates

Jay Powell’s Fed has hiked rates 75 bps in June and is set for another 75-bp hike next week.

I think this next rate rise will break the camel’s back.

The US economy can’t take much more medicine so quickly.

Usually, banks profit from a widening of the net interest margin.

That’s the difference between what they pay you in interest and what they make on their loans.

But this time, that widening isn’t enough to compensate for the lost investment banking revenue.

And that’s because companies are thinking twice about going public or financing deals.

Lack of Confidence

US consumers are burning through their savings because of the inflation in the system.

That’s forcing the Fed’s hand to raise rates.

But as the Fed raises rates, the USD keeps going up.

That means foreign consumers are finding it increasingly difficult to purchase US goods and services.

Volatility is increasing in the system.

That’s the one thing the banks were happy about: their trading revenues.

Traders had a field day this year, as volatility leads to profitability.

But investment bankers find the opposite: all this volatility and uncertainty wrecks the plans of company executives.

If executives don’t grasp what may come, they put off lucrative deals like initial public offerings, secondary offerings, and debt issuances.

From WSJ.com:

Stock underwriting, meanwhile, has gone dormant. The total value of U.S. initial public offerings was below $4 billion in the second quarter, down 97% from the record high in the first quarter of 2021. IPOs might not resume in earnest until business leaders have better insights on the outlook for inflation and economic growth.

Credit: WSJ.com

Rising interest rates and tumbling markets have wounded the market for deal financing, clouding the outlook. Walgreens Boots Alliance Inc. dropped plans last week to sell its Boots and No7 Beauty Co. businesses, saying bids came in too low in part because potential buyers couldn’t line up enough funding. Kohl’s Corp. cited the weak financing market when it called off deal talks with Franchise Group Inc. 

Wrap Up

Sometimes, it takes the big guys to get hurt to see what’s truly going on.

There’s no way Powell sat in the Eccles Building, watching bank earnings come out, thinking, “This is all going according to plan.”

How the big guys react to the Fed’s impending hike will dictate the Fed’s course for the rest of the year.

Until tomorrow.

All the best,

Sean

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