JPMorgan, Wells Fargo See A Rocky Road Ahead For The Banking Industry
Major banks last week reported mixed first-quarter results, with JPMorgan's net earnings dropping by 42%, while Wells Fargo & Co. missing revenue estimates.
Still, the leadership of the two banks hailed the results while warning of the downside risks ahead.
"JPMorgan Chase generated a healthy $30 billion of revenue, $8.3 billion of earnings and an ROTCE of 16% in the first quarter after adding $902 million in credit reserves largely due to higher probabilities of downside risks," said Jamie Dimon, chairman and CEO of JPMorgan.
"Lending strength continued with average firmwide loans up 5% while credit losses are still at historically low levels. We remain optimistic on the economy, at least for the short term – consumer and business balance sheets as well as consumer spending remain at healthy levels – but see significant geopolitical and economic challenges ahead due to high inflation, supply chain issues and the war in Ukraine."
Wells Fargo CEO Charlie Scharf was on the same page.
"We continue to invest to improve our digital capabilities with additional enhancements planned for this year,'' Scharf said about the company's earnings results.
"Our internal indicators continue to point towards the strength of our customers' financial position, but the Federal Reserve has made it clear that it will take actions necessary to reduce inflation and this will certainly reduce economic growth. In addition, the war in Ukraine adds additional risk to the downside. Wells Fargo is positioned well to provide support for our clients in a slowing economy. While we will likely see an increase in credit losses from historical lows, we should be a net beneficiary as we will benefit from rising rates, we have a strong capital position, and our lower expense base creates greater margins from which to invest."
Banks faced several tailwinds last year, like solid demand for loan originations due to the rebound in the U.S. economy from the pandemic recession and a robust housing market. As a result, they helped boost revenues and earnings, pushing bank shares higher.
Meanwhile, bank earnings got another boost from a rising spread, the difference between the short-term interest rate banks pay customers for deposits and the long-term interest banks collect from loans and investments in bonds.
The interest rate spread, or just as "spread" in Wall Street circles, is the critical metric of a bank's gross profit margin. It rises and falls with changes in short-term and long-term interest rates. When long-term interest rates decline faster than short-term interest rates, the interest rate spread narrows, squeezing bank profitability, as was the case during the pandemic recession of 2020. Conversely, when long-term interest rates rise faster than short-term rates, the interest rate spread widens, expanding banking profitability, as has been the case in the months that followed the end of the pandemic recession.
But with the Federal Reserve switching gears and the Russian-Ukraine war still raging, tailwinds can turn into headwinds. For instance, mortgage rates have doubled since the pandemic, cooling off the mortgage demand.
In addition, a slowing economy could be followed by rising loan defaults, which could require a boost of reserves for loan losses.
Meanwhile, the yield curve has been flattening, narrowing the interest rate spread and bank profitability.
"Megabanks reporting weak earnings were expected this quarter amid consumers' rising concerns about inflation and the risk of recession," said Gabe Krajicek, CEO of Kasasa.
"With as much as 60% of U.S. consumers living paycheck to paycheck, it's not a surprise to see spending cutbacks. Even with a strong job market and wage gains, pricing spikes in core spending categories, including food, gas, and shelter, are causing more Americans to cut spending. On top of that, Russia's invasion of Ukraine put a pause on investment banking revenues, which further hurt bank earnings. Although the pipeline and outlook for M&A activity remain strong, it stalled in Q1 and contributed to disappointing numbers."
The numbers could get more disappointing as the Fed is taking liquidity out of the economy and capital becomes scarce.
© Copyright IBTimes 2024. All rights reserved.