Boring is good when it comes to bank earnings. And it has only taken ten years of regulatory change and a long economic recovery to achieve boredom. As you remember, it was ten years ago this fall that the S&P reached its pre-crisis peak, and only nine years since Lehman Brothers collapsed into bankruptcy and plunged the banking sector into its worst crisis since the great depression.
Earnings are all good so far this quarter, as evidenced by the reported results of the largest U.S. banks. Revenues are up 2%, broadly in line with economic growth, and earnings per share are up a more exciting 14%, with some growth in interest income, good cost control and excellent credit quality all aided by generous stock buy-backs. With the U.S. economy still in recovery mode, robust earnings and bank balance sheets as strong as they have been in generations, results are predictable and safe. Boring is good.
We all know banks are cyclical and the good times do not last forever, so the question often raised is can we fall back into the bad old days when banks were failing and it was all way too exciting? We don’t see it.
The laws of economics have not been repealed and the economy will again fall into recession. Yet bank regulatory laws are far stricter today and banks are very well prepared for the next downturn. Dodd Frank has resulted in bank capital levels that are often twice pre-crisis levels, bank portfolios are stress tested yearly (and banks are not allowed to return capital unless they pass these tests), and banks are now required to hold large amounts of liquidity to protect themselves against the next inevitable run-on-the-bank. Finally, the Volcker Rule prohibits banks from making speculative bets with depositor money. While there are proposals to tweak some of these regulations, which would allow the banks to make a little more money, we do not expect any material change to these regulations that would weaken banks. Earnings could be a yawn for some time.
We like boring. It is a great attribute in high quality bond portfolios. We also like good earnings, strong balance sheets and a heightened ability to withstand the next downturn, regardless of when it comes. It may be a yawn, but at this point in the extended economic recovery, this is just fine!
Source: Barclays, Bloomberg, The Financial Times