As of this past Friday, 17 of the 18 banks in the S&P 500 have reported results for the first quarter and not only have the quantitative results been supportive of strong fundamentals, but the tone from management teams has also been consistently positive about business trends. While these banks have outperformed the broader market so far this year, the margin has been thin at just 2-3%: we think this gap is poised to widen considerably as the year progressed. We’ve summarized below our 3 most important takeaways from bank earnings thus far, which in totality keep us bullish on U.S. Banks.
1. Loan Demand Remains Strong Loan demand is arguably the most important fundamental indicator for banks.
The rapid rise in mortgage rates into an already very tight housing market has impacted demand for housing and in turn mortgage loans. As a result, investors feared that bank’s lending growth in 2022 would be severely impacted given how large the mortgage market is. However, while mortgage loan demand overall declined sharply in the first quarter, it has been offset by other categories, in particular commercial lending. As a result, banks including Wells Fargo, PNC, First Republic Bank and U.S. Bancorp during their first quarter results, guided to continued strong loan growth for the rest of 2022. This is even though mortgage originations are expected to decline sharply; for instance, earlier in the year, PNC had expected mortgage originations to decline “low single digits” in 2022 but now expects originations to decline by 25 to 30%. The strength in loan demand outside of mortgage loans is more than outweighing a very weak mortgage origination environment.
2. Rate Increases Will Accelerate Profit GrowthAt this point, the consensus expectation is for the Federal Reserve to raise rates steadily throughout 2022, and not surprisingly this is also the expectation of major U.S. banks. First Republic Bank previously expected 3 rate hikes in 2022 and now expects 7, while both Citizens Bank and PNC expect the Federal Reserve to raise rates to 2-2.5% by the end of the year. However, higher rates aren’t necessarily positive for banks as they impact both the topline (loan rates) and the expense line (funding costs), and so the net impact is a lot more nuanced. That said, one of the major differences between the current rate cycle and prior cycles is that banks have improved their funding mix, skewing their deposit bases more towards non-interest checking accounts. In addition to this, even for interest-bearing savings and checking accounts, past consumer behavior suggests that consumers don’t expect higher rates on their deposit accounts until the Fed Funds Rate breaks the one percent mark. In a nutshell, U.S. bank funding is less rate sensitive than it’s been in the past and any impacts from higher rates on the rate sensitive portions of banks’ deposit bases will be on a delayed basis. Combined this will allow bank net interest margins to expand, leading to accelerating profit growth for banks throughout 2022. 3. Credit Quality Remains Very Strong Deteriorating loan performance is one of the early signs of trouble in a weakening economy. If the economy softens not only will loan demand weaken but the performance of loans will also deteriorate resulting in an increase in charge offs which negatively impacts bank earnings. This is obviously an area of focus for investors given concerns about the U.S. economy weakening. But having now gone through over a dozen earnings reports from U.S. banks, the facts have been unambiguously supportive of continued healthy credit quality. Specifically, net charge offs as a percentage of bank loans continue to be near record lows for most banks and remain well below levels that would be concerning. For example, here’s a summary of the net charge off ratios for several large U.S. banks in the first quarter:
- Wells Fargo
- Bank of America
- JPMorgan Chase
- U.S. Bancorp – 0.21%
Finally, in addition to the three factors discussed above, the financial situation of the U.S. Consumer is healthier than it’s been in a long time. Not only do U.S. Consumers now have more than $25 trillion of equity in their homes (per Rocket Mortgage), but there is growing evidence that they have more disposable cash than they’ve had in decades. Bank of America performed an analysis on their customer base which showed that customers that had between $1,000 and $2,000 in savings at the bank pre-pandemic now had on average $7,400 in savings and for customers that had between $2,000 and $5,000 in savings pre-pandemic, they now had on average $12,500 in savings. U.S. Consumers are sitting on excess cash and also have record levels of equity in their homes. This creates a significant buffer to consumer spending and – given consumer spending is 70% of U.S. GDP – the U.S. economy.Bottom line: we think banks’ reported first quarter earnings indicate continued solid fundamentals and like the setup for them through the rest of 2022.
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