Bank Earnings, Regulation and Bond Portfolios

The so-called “earnings season” kicked off last week with J.P. Morgan (JPM) and Wells Fargo both announcing first quarter results: JPM net income dropped; Wells Fargo net income grew. Both remained firmly in the black, however, significantly lower trading volumes and mortgage originations weighed heavily on revenue. Wells Fargo was able to grow profits by releasing capital set aside for defaulted loans. With consumer delinquencies and loan-losses trending downward broadly, banks have increasingly been making use of “one-timers” like releasing capital reserves and utilizing tax benefits to improve headline results. The fact remains that for the sector as a whole, the core banking business is struggling to grow, partly due to increased regulation. Last week regulators released another initiative to further increase capital buffers at large banks, even beyond what their European counterparts have required. Though stocks may be adversely affected, this is great news for bond portfolios. Bonds perform well when corporations provide more reassurance they will pay back lenders. Additional capital accomplishes this goal. Specifically, it is estimated JPM will need to set aside about $16 billion in additional capital to meet the new requirements. This should drive a meaningful increase in JPM bond prices, which are held widely in SNWAM portfolios. Bank earnings may not be as solid as equity investors would hope, but bond investors continue to benefit enormously from increased capital buffers.