Year to date, big banks' earnings have been ho-hum (unless beating analysts' so-so estimates can be considered thrilling). Loan balances are flat while corporate banking and investment services seem to be peaking. Provisions for losses on loans are up as well. The market sent several of these stocks higher in the wake of their first-quarter reports anyway, recognizing things could have been worse.
However, there's one vital detail being glossed over in most of the discussions of the country's biggest banks' Q1 results: the upside of the recent interest rate increases that have been so painful to borrowers. Higher interest rates are leading to huge earnings improvements in banks' core business, which is lending.
Banks' once-biggest profit centers are back in a major way
As was said, the topic has been largely left out of post-earnings discussions so far. But higher interest rates tend to do banks more good than harm ... the bigger the bank, the better. Although they generally discourage consumers and corporations from taking out new loans, they don't outright prevent them from doing so. Meanwhile, adjustable-rate loans' effective rates are nudged upward when the Federal Reserve ratchets its benchmark interest rates higher.
The nation's major banking names are now clearly seeing the benefit of this trend taking hold.
Take Wells Fargo (WFC -0.03%) as an example. Although the difference between its interest expenses (on the money it's borrowing) and interest revenue (on the loans it's making) last quarter was essentially flat sequentially at $13.3 billion, that number was still decidedly stronger than its net interest income figures from 2021. While demand for new mortgage loans was soaring then, these loans were being locked in at rock-bottom rates.
Data source: Wells Fargo. Chart by author.
It's not just Wells Fargo though. Megabank Citigroup (C 1.41%) is seeing the same upside, producing another $13.3 billion worth of net interest income last quarter.
Source data: Citigroup. Chart by author.
JPMorgan Chase (JPM 0.06%) is benefiting too, and perhaps even more so. Last quarter's net interest income of $20.7 billion was the strongest the bank has seen since well before the COVID-19 pandemic took hold in early 2020.
Source data: JPMorgan Chase. Chart by author.
These bigger profits are sustainable
It's unlikely this growth will continue at its recent pace in the immediate future. The members of the Federal Open Market Committee for the most part only anticipate that they will hike the federal funds rate one more time this year before dialing interest rates back down -- somewhat -- over the course of next year and 2025. And, that's an outlook plenty of economists agree with now that the inflation beast is being tamed. If interest rates level off, so too will the net profitability of new and existing variable-rate loans and revolving credit agreements.
Rates will be stabilizing, however, at levels that make lending a more profitable business than it has been in a long while. The current federal funds rate is higher than it's been at any point in the past 15 years, after all. Rates will also be stabilizing at levels consumers and corporations can live with, even if they don't like them.
In other words, money will still be cheap enough to make borrowing it worth the expense of doing so. The federal funds rate is still lower than it has been for the majority of the past 50 years.
So, connect the dots. The business segment that was once banking's biggest cash cow -- and which has been weak for a long, long time -- is healthy again. That's good news for banks of all sizes, although the largest banks seem to enjoy a disproportional degree of the net benefit. Not only will these conditions help stabilize big banks' earnings that had become increasingly dependent on services like investment banking, payment services, and asset management, the increase in reliable cash flow from lending activity will help fund growth initiatives many banks of all sizes haven't been able to fully fund in years.
In other words, now would be a great time to step into big bank stocks if you don't own some already. The weak performances of Q1 2023 don't reflect the way their profit profile has improved in just the past few months.
