Every quarter large banks are usually some of the first out of the gate, and this quarter was notable, as four large banks all reported on the same day, and all of them beating street expectations. This is a good sign, as banks are often viewed as a leveraged bet on the economy.
Like the rest of the economy, growth is hard to find in the banking sector. In the absence of robust growth, bank earnings were generally supported by cost reductions and a continued low level of credit losses. Consumer credit losses are near cyclical lows, and there is no indication the U.S. consumer is losing the ability to make home, auto or credit card payments. Also, loans to energy companies are seeing improved performance as oil prices continue to improve. A highlight in the revenue picture is fixed income trading, where revenue saw a small pop as Brexit, money market reform and the potential for central bank action kept traders busy, while also boosting both revenues and earnings in capital markets divisions. However, the days when fixed income traders were referred to as “Masters of the Universe” are long gone in this era of tighter regulation and government intervention.
Recently, U.S. legislative hearings certainly played a large part in the “retirement” of John Stumpf, the long standing Chairman of Wells Fargo, this last week. He left to help Wells Fargo move beyond its recent troubles, which were caused by opening client accounts without permission. Wells is refunding customers $2.5 million in fees, and company executives will forgo close to $60 million in compensation. The added compliance costs will be substantial, and the breach of trust is certainly disappointing, yet the impact on customers and the business will be relatively small.
Tight regulation and laser-like focus from legislators is resulting in safer banks, which now possess some of the best credit fundamentals in the U.S. corporate credit universe. Capital and liquidity have doubled since the crisis in 2008, risky assets have been shed, and consumer protections have never been stronger. This is great for bondholders, but not as good for either equity holders looking for strong returns or bank customers looking for easy credit terms.
At SNWAM, we are taking advantage of these good fundamentals by maintaining our overweight credit exposure in banks. Nonetheless, we prefer to take our exposure in short maturities where there are attractive break-evens and a reduced the risk from spread widening and company specific credit events.
Source: Wells Fargo, JPM, Citicorp, PNC, Barclays, and Bloomberg