It's been a tough couple of years for banks, and by extension, for bank stocks. Although the interest rate hikes seen since April of last year improve lending's profit margins, they can also crimp demand for loans. There's also the collapse of SVB Financial's Silicon Valley Bank and First Republic Bank early this year, exposing similar liquidity risks being faced by other names in the business. Never even mind the fact that the inflation these rate increases were meant to curb is still with us.
Given all of this, it can't be entirely surprising the Dow Jones U.S. Bank Index is down 37% from its early 2022 peak.
Banks, however, just aren't in the sort of trouble most investors feared they'd be in at this point.
Three for three
The recently released quarterly results from megabanks JPMorgan Chase (JPM 1.36%), Citigroup (C 2.74%), and Wells Fargo (WFC 3.90%) show all three of these companies knocked it out of the proverbial park last quarter, suggesting other banks may soon be dishing out similarly strong numbers. They may even be strong enough numbers to start pushing all of these stocks higher again.
All three banks reported year-over-year revenue growth. Ditto for earnings. Last quarter's top and bottom lines also topped analysts' estimates. Those aren't the most important clues that investors may be underestimating the entirety of the banking industry at this time, however. All three of these banks also passed their industry-specific performance tests.
Loan losses remain relatively modest
Perhaps the top concern regarding banks lately has been the impact of economic weakness on the performance of their loan portfolios. Namely, investors worry because delinquencies and defaults started soaring just within the past few months. There are challenges on this front, but not as many as one might expect.
Take JPMorgan Chase as an example. Its provision for credit losses actually fell year over year and about half of what it set aside in its second-quarter budget for loan-related losses. Meanwhile, the gradual growth the bank saw in delinquencies and charge-offs on auto, mortgage, and credit card loans since the middle of last year seems to be slowing down (maybe even leveling off). In this same vein, JPMorgan Chase's total allowance for losses as a percentage of its total loan portfolio has actually been sinking. This provision came in at 1.24% of its total loans for the quarter ending in September versus 1.3% a quarter earlier and 1.31% in the quarter before that.
NYSE: JPM
Key Data Points
And it's not just JPMorgan showing such progress. Citigroup's Q3 allowance for losses on loans fell dramatically on a sequential as well as a year-over-year basis, and its allowance for credit losses as a percentage of loans held steady at just under 2.7% for over a year now. Although Wells Fargo is now expecting more loan losses than it has of late, this increase probably has more to do with the timing of the booking of its expected losses, which were very low in last year's Q3. Last quarter's charge-offs still only account for 0.36% of its total loan portfolio, and a relatively modest 0.87% of its loans are currently considered nonperforming.
These numbers could have been considerably worse given all the recent rhetoric about struggling consumers.
High interest rates are doing more good than harm
Speaking of loans, although higher interest rates make loans more expensive (in turn, crimping demand for borrowed money), the net benefit of higher rates is thus far helping banks more than it's hurting them. More of Wells Fargo's borrowers may be falling behind, but the company's overall net interest income last quarter was actually higher year over year to the tune of 8%. Citigroup's was up 10% year over year. JPMorgan Chase's interest income grew by 30%, although the 4% increase from its Q2 net-interest income is arguably a more accurate reflection of its current interest-based income growth.
This sounds impossible in light of the economic backdrop. But it isn't.
See, many consumers and corporations need borrowed money regardless of its cost. Although higher interest rates are making life miserable for borrowers, banks' cost of the capital they're lending out hasn't grown to the same degree. Said another way, the higher interest rates go, the wider the spread between banks' customers' interest rates and the interest rates these banks are paying on the money they're lending.
NYSE: WFC
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Banking-related performance metrics are improving
Last but not least, although terminology like tier-1 capital ratio and return on tangible common equity (or ROTCE) don't mean much outside of the banking business, within the banking industry they're important measures of how efficiently banks are using their assets.
And so far this earnings season, banks are looking healthy in one key way. That is, ROTCE figures are mostly rock-solid. Wells Fargo's Q3 ROTCE figure of 15.9% is up from Q2's comparison of 13.7% and much higher than the year-earlier number of 9.8%. JPMorgan Chase's is actually down from its Q2 comparison but down from an incredible 25% to a still-incredible 22% now. That's also still well up from the year-ago ROTCE figure of 18%.
Citigroup's Q3 ROTCE number of 7.7% looks relatively weak compared to JPMorgan and Wells Fargo's. It's also down from the year-ago comparison of 8.2%. Even so, Citi's per-share book value and tangible common equity value -- also measures of balance-sheet health -- continue to inch forward. And as a reminder, Citi was one of a handful of banks that didn't exactly pass the Federal Reserve's 2023 so-called "stress test" with flying colors. The Fed required the bank to increase its stress-capital buffer as well as the amount of its tier-1 common equity, thus limiting more fruitful ways of utilizing its assets. This is at least one of the reasons Citigroup's Q3 ROTCE is less than thrilling.
NYSE: C
Key Data Points
Banks stocks are more buy-worthy than expected at this point
There are risks to be sure. In light of the military conflict in Ukraine (and now in Israel-Palestine), soaring government and private debt levels, and the threat of even more rate hikes, JPMorgan's CEO Jamie Dimon cautions: "This may be the most dangerous time the world has seen in decades." It's possible these three banks and their peers could still show signs of growing distress in the foreseeable future.
Take a step back and look at the bigger picture though. The worst-case scenario is rarely ever actually realized. Indeed, most members of the Federal Reserve's open market committee expect interest rates to steadily peel back from 2023's elevated levels through 2026. These same Fed governors also recently raised their long-term economic growth outlooks, while at the same time lowering their long-term unemployment rate expectations. Their outlooks underscore the idea that the global economy will ease its way out of weakness without ever actually slipping into a full-blown recession.
Given this backdrop, it's not a surprise all three of the aforementioned bank stocks bolted higher last week following the release of their Q3 earnings results. They're still well down for the past several months though, as are most other banking stocks, on misguided assumptions about how much trouble they'd be in at this point in time.
That of course is your buying opportunity.
