The big banks have benefited from a confluence of a rising interest rate environment, post-pandemic economic rebound, financially strong balance sheets, a robust housing market, and the easy passage of annual stress tests. Earnings season kicks off in January for all the major financials. The most recent earnings reports from the core financials such as Bank of America (BAC), JPMorgan Chase (JPM), and Goldman Sachs (GS) all reported very strong quarters with stock prices breaking out to all-time highs prior to the Q4 overall market turbulence. The biggest banks, by assets, posted profit and revenue that beat expectations. These results came on the heels of booming Wall Street deals and the release of funds previously earmarked for pandemic-related defaults. The big bank cohort is in a sweet spot of a post-pandemic consumer, with rising rates and balance sheets to support expanded share buybacks and dividend increases. These stocks are inexpensive and stand to capitalize on all these tailwinds heading into 2022.
The pandemic has been going on for two-plus years, and the big banks have navigated the coronavirus volatility over this stretch. Throughout the rolling pandemic, the consumer has been resilient, and the potential worst-case financial downsides did not materialize (i.e., massive loan defaults). In addition, the consumer has been strong in retail, housing, autos and the overall holiday spending was robust.
Bank of America CEO Brian Moynihan stated that whether it was a return to loan growth, credit-card signups, or economic indicators like unemployment levels, the company was back in expansion mode. "The pre-pandemic, organic growth machine has kicked back in," "You see that this quarter, and it's evident across all our lines of business." Loan balances at BAC increased 9% on an annualized basis from the second quarter, driven by strength in commercial loans, the company said.
Per JP Morgan, spending levels that are roughly 20% higher than before the pandemic will eventually result in more credit-card balances, and loan growth should accelerate into next year. That means that banks' loan books are set to expand at the same time the industry is still benefiting from reserve releases and historically low default rates. Add in rising rates as the Federal Reserve eases off the accommodative measures taken to stave off an economic collapse, and bank profitability is set to jump. JP Morgan CEO Jamie Dimon stated, "Two years ago, we were facing Covid, virtually a Great Depression with the global pandemic, and that's all in the back mirror."
2021 Financial Stress Tests Easily Pass
The 2021 stress tests were easily passed and indicated that the biggest U.S. banks could easily withstand a severe recession. In addition, all 23 institutions in the 2021 exam remained "well above" minimum required capital levels during a hypothetical economic downturn.
That scenario included a "severe global recession" that hits commercial real estate and corporate debt holders and peaks at 10.8% unemployment and a 55% drop in the stock market, the central bank said. While the industry would post $474 billion in losses, loss-cushioning capital would still be more than double the minimum required levels, the Fed said.
Pandemic-related restrictions hindered the banks' ability to return capital to shareholders via dividends and buybacks. Those restrictions will now be removed based on the recent stress test results. Now the banking industry can hike buybacks and dividends by billions of dollars after the green light back in July 2021. Nearly all banks have since increased their payouts to shareholders.
Impending Rates Hikes
Federal Reserve indicated that the central bank would begin withdrawing its stimulatory monetary policies in 2022. Although interest rate hikes are likely off in the distance, the economy has reached a point where it no longer needs as much monetary policy support. This pivot in monetary policy by the Federal Reserve sets the stage for the initial reduction in asset purchases and downstream interest rate hikes. The speed at which rate increases hit the markets will be in part contingent upon inflation, employment, and of course, the pandemic backdrop. Although rising rates may introduce some systemic risk, the financial cohort is poised to go higher.
It's no secret that inflation has run hot for a while now and that the Federal Reserve may need to play catch up and accelerate rate increases sooner rather than later. Banks will benefit with steady rate increases over time as this feeds into margin expansion on loans and windfalls of interest on the float the bank holds in their deposit base.
The financial cohort has benefited from a confluence of a rising interest rate environment, post-pandemic economic rebound, financially strong balance sheets, a robust housing market and the easy passage of the 2021 annual stress tests as 2022 is on tap. The biggest banks, by assets, posted profit and revenue that beat expectations. These results came in part due to the release of funds previously earmarked for pandemic-related defaults, which failed to materialize.
The banks are much more resilient and capitalized and have demonstrated their ability to evolve in the face of the rolling coronavirus pandemic. The 2021 stress tests were easily passed and indicated that the biggest U.S. banks could easily withstand a severe recession. All 23 institutions in the 2021 exam remained "well above" minimum required capital levels during a hypothetical economic downturn. Inevitably, low-interest rates will not be here indefinitely, and bond purchases will need to subside, thus pivoting to a scenario of higher rates in the intermediate term. The big banks present compelling value, especially with rising rates coming into the fold in 2022, which may serve as a long-term tailwind for banks to appreciate higher.
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