Modern banks may have a variety of different sources of income, but the vast majority of most banks’ profits still come from net interest income, which is the difference between the interest income they earn on loans and the interest they pay out to depositors.
Investors and analysts alike have been fearful going into bank earnings season because, despite higher interest rates promising to boost profitability, banks still may not necessarily report earnings growth if deposit outflows outweigh better margins on remaining deposits. After the failure of Silicon Valley Bank, the danger of customers yanking cash out of bank accounts is undeniable, and the public receives little reliable transparency on such numbers outside of quarterly earnings reports.
JPMorgan Chase & Co. (JPM, Financial) blew those worries out of the water when it reported its first-quarter 2023 earnings on Friday, breezing past analysts’ expectations and first-quarter 2022 numbers thanks to 49% year-over-year growth in net interest income. As it turns out, the “too big to fail” bank saw “significant new account opening activity” in its commercial bank as depositors rushed to safety. JPMorgan’s shares gained over 7% on the news.
An intra-quarter commercial turnaround
According to JPMorgan’s commercial banking segment Barnum, deposit inflows were not a theme of the entire quarter. Instead, they implied “an intra-quarter reversal of the recent outflow trend as a consequence of the March events [Silicon Valley and other bank failures]… We estimate that we have retained approximately $50 billion of these deposit inflows at quarter-end.”
In fact, one could say the recent troubles with the banking system were JPMorgan’s saving grace. Thanks to high inflation, there has been a trend of depositors pulling money out of the regulated banking system and putting it to use earning higher yields in places such as money market funds. When inflation rates are near 2%, it is easier to justify higher cash deposits, but when inflation is double to quadruple that amount, keeping a high amount of cash in the bank is like burning money.
Despite the recent influx in deposits, JPMorgan’s deposits are still down 7% year over year to $7.38 trillion. However, higher interest rates more than made up for the difference, boosting net interest income by 49% year over year to $20.8 billion. For the full year of 2023, JPMorgan now expects $81 billion in net interest income, which is $7 billion above its previous forecast.
Which banks could follow in JPMorgan’s footsteps?
With JPMorgan stock gaining 7% in a single day, all eyes will be on other major bank earnings to see if they can replicate this performance. Bank of America Corp. (BAC, Financial) was up 3% following JPMorgan’s earnings report, while Morgan Stanley (MS, Financial) and Goldman Sachs Group Inc. (GS, Financial) were up 1%; all three report earnings next week.
Bank of America notably reported seeing net deposit inflows directly following the Silicon Valley Bank collapse, so it seems possible that it could follow in JPMorgan’s footsteps and report a surprise earnings beat. Morgan Stanley might benefit from the increase in bond investments reported by BlackRock Inc. (BLK, Financial), and credit ratings certainly seem more valuable as the risks of bankruptcy rise along with interest rates.
Citigroup Inc. (C, Financial) also reported its earnings on Friday, with shares gaining 4% after it beat expectations thanks to higher interest rates boosting personal banking revenue by 18%. The company did not make any particular note of inflows, but it did say deposits were about the same as the prior-year period at $1.3 trillion as outflows from wealthy clients moving more money to fixed income were offset by an increase in institutional certificates of deposit.
Why “too big to fail” banks could outperform
Once a term meant to villainize big banks for relying on their status to get away with overly risky and selfish business practices, “too big to fail” seems to have become a reassurance of safety amid the ongoing economic downturn and the regional banking crisis. Depositors, especially companies, are looking for the best “safe haven” for their cash, which should help slow down net outflows even as interest rates remain higher than they were a couple of years ago.
Meanwhile, smaller banks could continue to struggle as continued outflows mean they could end up having to sell Treasury securities at a loss. When interest rates were near zero and easy money policies were in place, deposits stacked up, and as they usually do, banks used the cash to purchase Treasury securities. However, these securities decrease in value when interest rates rise, so having to take a loss on too many of them can be a disaster; that is what happened to Silicon Valley Bank.
Some value investors may be tempted by high dividend yields at regional banks following selloffs. For example, PacWest Bancorp (PACW, Financial) and First Republic Bank (FRC, Financial) are showing dividend yields of 8% and 10%, respectively, after their share prices plunged following bank runs. However, these yields are not likely to stay considering higher interest rates cannot make up for deposit losses, and there is still a risk of further bank runs and credit losses if the economy continues to weaken.
Thus, even with more modest dividend yields around the 2% to 3% range and price-earnings ratios in the high single digits, I still expect the top names in banking like JPMorgan, Bank of America and Citigroup to continue to lead the banking sector. Their status has truly solidified since the financial crisis, giving them an existence akin to safe-haven assets for depositors.
