Waves of concern continue to ripple across the global banking sector, writes David Buik

27 April 2023, 06:57

By David Buik

@truemagic68

On Friday 14th April and Tuesday 18th April, there was a slew of great US bank earnings, including JP Morgan, Citibank, Wells Fargo, and Bank of America.

After the crisis created by SVB Bank, First Republic Bank of California, and Signature Bank and even more worryingly from the demise of Credit Suisse, which caused bondholders to lose circa $17 billion, the quality of these earnings came as a bit of a welcome surprise.

What market observers may well have not taken into consideration, was the aggressive stance taken by the FED in the last year. Rates had risen from 0.25% to 4.5%.

This action created an environment for banks to increase their income for the last quarter by between 23% and 50% - unprecedented in recent years. Of course, markets have enjoyed lower interest rates for nearly 15 years since the banking crisis of 2008/9 – hence the misjudgement by market observers and analysts.

Apart from Wells Fargo, these banking shares bounced quite sharply by between 4% and 7% in response to the unexpected strength of these results, before easing back. It is interesting to note that First Republic Bank of California announced it had suffered $100bn of customer withdrawals between January and March, sparking concerns about its financial health.

Its shares have fallen 79% in two days, sending ripples of concern through the US banking regulators.

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However, these earnings were hardly Utopian. Provisions for bad debts were measurable – JP Morgan $2.3bn, Citibank $2.4bn, Wells Fargo $1.21bn and Bank of America $931 million respectively. It then became clear that on Monday 17th April 2023, State Street Bank, Charles Schwab, and Northern Trust had surrendered $60 billion of deposits since the SVB/Credit Suisse ‘faux pas.’

State Street shares fell by 18%, ending Monday session down 11%. Technology and social media now move faster than the speed of lightning, allowing a gargantuan level of deposits to see alternative accommodation elsewhere, in a heartbeat! Banks have received a real wake-up call, as have regulators, due to the damage caused by uncertainty.

The volatility of a bank’s deposit base could well continue to cause measurable damage to the stability of the international banking sector.

A continuing negative factor that could manifest itself from this anomaly, could be that banks may become reluctant to lend money, by tightening their belts. This could stifle growth and lead to a modest recession in the next year.

As for the investment banking community, Goldman Sachs did not exactly cover themselves in glory.

Profits fell 18% thanks to weaker bond trading than expected and a dearth of corporate finance opportunities. A loss of $470m was incurred on ‘Marcus’ loans.

Morgan Stanley fared slightly better, with first-quarter forecasts topping estimates from better-than-expected trading results with revenues of $14.52 billion, though profits fell 19% to $2.98 billion.

In years gone by, Europe’s banking sector was always considered a jewel in its crown – with UBS, Credit Suisse, and Deutsche Bank very much in the vanguard - Sadly, this is not entirely the case today.

There is little point in dwelling on Credit Suisse’s plight. Suffice to say they fell fortunately into the attentive arms of UBS. It is worth recording that in the last quarter of 2022, Credit Suisse lost CHF 110 billion of deposits and CHF 61 billion in the first quarter of 2023!

This seismic movement illustrates very succinctly how neurotically sensitive deposit customers are to the advent of instability. In the last quarter, UBS increased its provisions of $665 million associated with residential mortgage-backed securities litigation issues.

The Swiss banking mogul also attracted $28 billion in net new money into its global wealth management unit. Notwithstanding that news, UBS reported a 52% annual drop in net profit to $1.03 billion.

Sergio Ermotti, UBS’s distinguished CEO has not underestimated the magnitude of the task of bedding down Credit Suisse into UBS’s operations.

One suspects there will be solid support from the Swiss Central Bank. However, the threat of litigation may play more than a spear-carrying role in their adventure.

Santander has performed splendidly this year, with its shares rallying by 14% this year. It might have been more, but for the imposition of a €224m windfall tax. Profits were down to €2.57 billion.

Earnings from Deutsche Bank this Thursday offered hope. It posted a pre-tax profit for the first quarter of €1.9 billion – up 12% on net inflows of €7.7 billion – up 5%.

Trading revenue was down 17%. Tier One Capital came in at a decent 13.6%. Provisions for bad debt came in at €372 million.

These are decent numbers, but investors still need convincing that Deutsche’s shares are on the march. Since 2007, just before the banking crisis, Germany’s premier bank’s shares stood at €93.

Today’s share price is €9.56, despite copious rights issues over the years. Deutsche Bank has never really recovered from what the market perceives to have been dramatic over-involvement in derivative trading – at the time probably the largest in the world. Disengaging from large positions has proved challenging and the recovery process has been painful.

I will post news on UK bank earnings next week. It will be interesting to draw comparisons with their European/US peers.

What concerns most market observers is whilst these ripples of concern prevail over the brittleness of the banking sector, lending may contract, thus stifling growth prospects across the world.