Episode Transcript
The Finance Ghost: Welcome to episode 296 of Magic Markets. This week we are talking about the banks because US earnings season has kicked off, which is always very exciting. And, as is traditionally the case, it's the big banks that come out into the headlines first.
Moe, we've heard from most of the majors now. I'll be focusing on Bank of America just now and we're also covering one of the banks in Magic Markets Premium this week.
But before we get to any of the specifics, what's your read on this reporting season, as a whole?
Mohammed Nalla: Yeah Ghost, I'm going to jump right into it because I think, in short, they're signalling that we're not in a recession in the US (or at least, not yet).
Some of the key themes would be three things: 1) Are the banks still growing? 2) What's happening with credit quality? And then, most importantly, I would say is 3) where are these banks actually making their money?
Jumping into the first point on growth, I would say it's broadly positive. And if we look at the biggest one there, JPMorgan – their average loans rose 10%; their deposits grew 8%. Citibank, that's another big bank. Their loans rose 12%; deposits, up 9%. So, you can see similar kind of trends there.
And then Wells Fargo (which I would see more as a Main Street bank) grew both loans and deposits by around 11%. So, you can see some pretty decent numbers coming through there.
And, interestingly enough, the net interest income (NII) also increased across the board on those three. So, that's really a sign that the economy isn't falling into a recession. There are some cracks below the headlines, but in aggregate, activity levels are looking relatively strong.
The Finance Ghost: That bodes well, right? NII is the most traditional metric in banking. If that's going well, then I guess that suggests good things for the consumer, perhaps?
What did some of the other things like credit cards actually tell us about the trends in US consumers?
Mohammed Nalla: Yeah, I would say that the consumer in the US remains resilient, but not invincible. We've seen some of the headline data indicating some of the cracks.
If we look at something specifically like card spend (which is a good proxy for consumer activity), that rose around 10% at JPMorgan, 11% at Citibank, and in aggregate, loan balances are growing.
Most consumers are still keeping up with their repayments, but the problem with higher rates (as we've seen in the US) is that they cut both ways.
They can support bank interest income, but they also raise deposit costs and suppress mortgage activity (we know activity in the housing market in the US has gone very quiet).
In aggregate, higher rates make deals more expensive to finance. So, if rates stay high for long enough, I think credit losses will eventually start to follow through.
We’ve had these reserve builds at Citibank and at Wells Fargo, and those are worth watching. Because even though the actual credit data remains fairly benign, it is actually a pressure point that you're going to have to watch, depending on how long rates stay high.
This brings me nicely to the second point I wanted to raise, which was credit quality. If we look at JPMorgan's card charge-off rate, that was around 2.9%. Wells Fargo's total charge-off rate was actually slightly lower than it was a year ago, and its non-performing assets also fell. So, credit quality is not a problem at those banks.
And if you look at Citibank and Wells Fargo, they did increase their provisions for future credit losses. What's the read on that? I would say caution from the banks, but not a realised deterioration in credit quality that's evident yet.
Now, we must also note a very important point here. That is that these are the larger banks, who tend to have the relatively prime customer bases. So, I would say a little bit of caution around that in that healthy aggregate banking data doesn't mean that every single part of the consumer economy is healthy.
And then, Ghost, just to touch on one last point, where are these banks making their money? Because this was really the interesting one for me.
Equities trading, that was extraordinary. If you look at Goldman Sachs's equities revenue, it rose 72% and JPMorgan's increased 49%. So, really strong performances coming through from that particular segment.
But by contrast, if you look at fixed-income trading, that was flat at Goldman Sachs and it fell 4% at JPMorgan.
So, the volatility you've seen in markets in general, both equities and bonds, has created substantial revenue in equities (derivatives, prime brokerage – all doing quite well). But the rapidly changing interest rate expectations have been a headwind for bond trading, as well as getting some of those corporate deals across the line.
The Finance Ghost: Interestingly enough, the Fixed Income, Currencies and Commodities (FICC) business didn't do so well at Bank of America either, as I'll chat about just now. But let's just look at JPMorgan in a bit more detail here, Moe. That's one that's pretty close to my heart.
It was a rare miss, wasn't it? Maybe just take us through that, because obviously that's not a great thing to see. And it's not something you see every day. Generally speaking, Dimon and his crew hit their targets.
Mohammed Nalla: Indeed, a very rare miss. They reported $5.57 per share against expectations of around $5.85. This was the first miss since late 2023. That tells you how rare this actually is.
And even if we exclude the losses on investment securities, earnings were then $5.75 versus the expectations at $5.85. So, I think that was the miss that the market was talking about.
But if you look at it at group level, net income still rose 6%, and revenue was up 8%. There were other pressure points, yes. I think cost was a pressure point – that rose 12%.
The read-through here, I would say, is not panic stations for the largest US bank, rather than just a very good bank that's failing to clear what the market had set as an exceptionally high bar of expectations. I think that context is very important.
Against that backdrop, Ghost, you mentioned something around Bank of America, the FICC business not doing so well. Let us go through what Bank of America looks like and how it fits within this current overview of the banks.
The Finance Ghost: Yeah, absolutely. Let's start by just giving some context to the performance. Bank of America hasn't really been a winner over the past year. It was down 1.5% when I looked, roughly in the same territory then as Wells Fargo. JPMorgan's up 12.5% over the same period.
Citigroup on the recovery trail, up 25%. If you draw a longer-term chart of Citigroup, you'll see what I mean about recovery there. But still, that's obviously a really good performance over the past 12 months.
Now, as the name suggests, Bank of America is focused on the US (shock and horror). Second-largest bank in the US (measured by assets), over 3,500 branches there.
That gives us an important clue, actually, because this is more of a traditional bank than your storied Wall Street names like JPMorgan, Morgan Stanley or Goldman Sachs. They have a massive deposit base and that means they have a lot of money to lend out. So, when interest rates go up quickly, they can reprice their assets very quickly.
That's good news, because that gives you that NII and endowment uplift. Not necessarily the boost, though, from the activity in markets that the Wall Street names might enjoy.
Bank of America does have an important wealth management business in the form of Merrill, but they don't have as much traditional investment banking, advisory and all the rest. Certainly not compared to Goldman Sachs, for example, which is very focused in that space.
What this means overall is that US consumer health is very important here. And it leads to a pretty fun thought that I had while prepping for this, which is that if the markets are really active (I'm talking equity markets now, and just flows in general) and maybe there's more happening at corporate level than consumer level, for example, it seems like Bank of America would probably underperform the likes of JPMorgan.
But if you have a period where consumers are very active, and perhaps the capital markets are not, then could Bank of America outperform?
Now, in theory, yes. It's this Main-Street-versus-Wall-Street point, in terms of how these different businesses tilt. But I think you do have to wonder about whether equity markets would be tepid in a scenario where Main Street is doing really well. You've got fiscal policy and the financialisation of the economy that has really supported equity markets in recent years.
So, it feels like if the consumer is doing really well and Main Street is doing really well, then Wall Street's probably also doing quite well. And that makes me think that Bank of America is probably more likely to underperform the JPMorgans of this world than outperform them.
I went back 10 years to test this thesis. If you look at just annual share price performance (so, not trying to do multi-year performances, just literally snapshot, 1 January to 31 December each time), then Bank of America outperformed JPMorgan in several of those pre-COVID years – 2016, 2017, 2019 – and 2021 as well.
But since 2022 (which of course is like midway through the pandemic), JPMorgan has come out ahead every year. So, it just feels like perhaps JPMorgan has the better overall business in this environment, which is interesting.
And that's why it's one of my big exposures, certainly from a banking perspective, and I don't have any Bank of America shares. But yeah, I just wanted to test that thought with you, Moe, because I think it's quite an interesting thing to work through.
Mohammed Nalla: Yeah, I think that's directionally right. But I would be careful about making that Main-Street-versus-Wall-Street distinction too binary. Because JPMorgan also has an enormous consumer and deposit franchise, and Bank of America, as you mentioned, has a meaningful markets and wealth management business.
So, I would say it's better to look at the number of earnings engines that each bank has and just how much capital it has available to support them.
Bank of America potentially has more sensitivity to higher interest rates, but it can outperform if assets reprice faster than deposits, the yield curve becomes more favourable, and its enormous deposit base remains relatively cheap.
But, that same rate environment can also raise deposit costs and create further pressure on securities portfolios, so it's a lot more nuanced.
And then JPMorgan, they could monetise consumer payments, investment banking, trading, and they also carry a much larger capital buffer. And so that diversity, as well as the capital buffer, does deserve a premium.
Bank of America could still outperform if it's sufficiently cheaper or if rates and regulatory capital rules move in its favour. But I would say, structurally, JPMorgan has more ways to win and more room for error.
The other complication in the Bank of America result was the $1.2 billion regulatory settlement I read about. Ghost, what exactly went wrong there?
The Finance Ghost: Yeah, so that's a big number. That's billion with a ‘B’. That's dollars, of course. It's because Bank of America has been found wanting when it comes to sanctions compliance and anti-money laundering.
This is obviously really important stuff for the banks, so there's a bigger trust and reputation point here that's worth thinking about and it really came through strongly in the latest quarter when you look at the questions from analysts.
Essentially, what's happened is that the progress made by the bank hasn't been sufficient for the regulators since 2024, when the issues were first raised. So, they've now come down with a fine.
The bank can absorb it fairly easily, let's be honest, because it only represented 15% of quarterly profit of $8.1 billion. So, not even 15% of annual, just quarterly. They make a lot of money over there.
But it's a bad look for management. Because it does raise questions about whether they actually are in control when it comes to these issues around compliance and everything else.
It also requires ongoing investment in systems and general compliance to ensure that it gets sorted out now. So, obviously that creates some other difficult questions around costs.
Mohammed Nalla: Yeah, it's never good to see this stuff coming through, but hopefully it's just a bump in the road that they will sort out now. What did you learn from the latest quarterly numbers about the overall performance at the bank?
The Finance Ghost: Yeah, so if we dig into that profit split (just to give you an idea of where the group makes its money), you've got about $3.5 billion consumer, $2 billion commercial lending and $1.5 billion in wealth management, if you take the same segmental view here.
And as mentioned previously, the wealth management side is useful, for sure, but it is the smallest part of the business, so just keep that in mind.
The consumer business, that's the bulk of it. That’s still growing. Nearly eight straight years of quarterly growth in chequing accounts, which is quite amazing if you think about it. 200,000 net new core accounts this quarter, taking them to a total of 39 million. That's a lot of bank accounts.
Commercial loans grew across every segment. And on the wealth management side, there was a 17% pickup in asset management fees, which is great. Compare that to the 3% growth in group revenue and you can see just how important that growth engine is.
Then, return on allocated capital in wealth management was 28%. So, it's quite a lucrative source of growth as well. And the cross-sell is working here, because 67% of Merrill clients on the wealth management side have bank accounts with Bank of America. So, just a really important business for them.
And then, interestingly, headcount, that's down nearly 3,500 people from a year ago. Now, to quickly give you context here, they have 209,000 people working for them, so 3,500 is perhaps not as big a number as you might think.
It's not that they're getting rid of people, it's that they're actually just not replacing people when they leave. And this obviously speaks directly to technology, AI and how staff attrition gets replaced by yet another LLM, rather than another person. So, revenue per employee – up 10%, which is good news for investors.
But, there’s some bad stuff as well. Markets, investment banking, revenue – down from prior periods, especially the FICC business. Those rapidly shifting interest rates really hurt them, as it seems to have done across the sector (as you raised earlier).
Common Equity Tier 1 (CET1) ratio is 10.9%. Now, that's down 35 basis points from the second quarter. Compare it to JPMorgan at 13.9% – that's a 300-basis-point difference in the capital at JPMorgan versus Bank of America.
The regulatory minimum currently is 10%, so Bank of America is still well ahead of the threshold. By the way, that shows you exactly why Jamie Dimon jumps up and down all the time about JPMorgan being overcapitalised and how it's just far too conservative [laughing].
Be that as it may, Bank of America describes that 90-basis-point margin as having flexibility. Now, as an analyst pointed out on the call, the CET1 minimum is going to go to 10.5%.
So, based on where they are right now (and assuming that's how the interpretation of the rules actually goes), it's a margin of only 40 basis points above their minimum. So, the question is, will that negatively impact the run rate of roughly $6 billion in buybacks per quarter?
Well, management is downplaying that for now, but that is definitely something to think about. Because these buybacks do tend to act as support for a share price in the market, and it would be better if they just had a little bit more flex on the balance sheet than they seem to have.
Mohammed Nalla: Yeah, Ghost, the guidance is always really important in these stocks. What has management actually indicated about the future?
The Finance Ghost: Yeah, the guidance is very important indeed. So, the critical underpin here – and I want everyone to listen very carefully – Bank of America is expecting three 25-basis-point increases in the interest rates between now and June 2027.
Now, for South Africans (bearing in mind that the SARB basically tracks the Fed almost exactly in terms of shape), just listen carefully to that and think about that before you take on more debt right now.
Bank of America might be wrong, of course, but that's the direction of travel they are expecting.
Now, as a bank with a large lending business, you would expect this to be good for them. Their guided NII growth is 8% next year. So yes, that will be good for them, assuming it comes through. That's above the medium-term guidance of 5% to 7%.
They were challenged on the call about whether or not that's a rates-driven growth rate or if there are other factors here. Their view is that other things are helping here, like the 4% to 5% growth that they expect in deposits, for example. That will obviously help with NII.
And then, further down the income statement, they expect operating leverage of 200 to 300 basis points over the medium term, even with the costs related to this regulatory penalty and all of the compliance things that they need to put in place.
And then a final point, Moe: there was a fascinating conversation on the earnings call about whether the use of agents could allow consumers to optimise their yield on money market accounts and take back some of the economics from the banks.
Simply put, the banks all offer different rates at different times on money market accounts. If you have an agent out there to whom you said, "Go and give me the best deal. Put my money in the bank that offers the most,” then technically, if all consumers do that, it does make life more difficult for the banks because it makes the pricing even more competitive.
Now personally, I think there's very little chance of people doing that en masse – think about the trust required with these agents. But it is interesting food for thought.
In case you were wondering, the management team did somewhat downplay it in line with what I think is to be the case, which is that most people are probably not going to do that. They're going to just use the money market accounts where they have their primary bank account, as long as the interest rates are roughly in line across the banks and there isn't a huge differential.
Mohammed Nalla: Wow, that's quite fascinating. I like the fact that the guidance points you've just raised bring us full circle back to the macro sensitivity of the business. I mean, the expected 8% growth is partly going to be betting on those three rate increases.
But the key variable isn't where the Fed takes rates, it's really what happens to deposit pricing. If Bank of America can reprice their assets faster than they have to pay their depositors, margins will expand.
But if customers become more aggressive about moving cash into higher-yielding products, then those deposit costs are going to rise and some of the benefit will disappear.
That is why maybe I'm a little bit less sanguine than you are on that point around financial agents. I think it's more important than it initially sounds.
Because, even if widespread adoption is unlikely in the near term, the technology will make deposits easier to move. That would increase the rate sensitivity of customers and potentially weaken one of the most valuable parts of the traditional banking model, so let's watch that one quite closely.
Overall, Ghost, to bring the show to a close, the reporting season gives us no obvious hard-landing signal. Consumers are spending, loan books are growing, actual credit losses are still manageable.
But higher rates are not an uncomplicated positive. They support interest income, but they simultaneously increase those funding costs. I think that's the point that lands with me.
I want to raise one very last point, because there's a second-order AI angle that we haven't really contextualised. That is that banks are expected to generate around $8.5 billion globally from AI-related investment banking fees this year. That's more than double last year.
That AI boom, it's real. It's feeding underwriting, lending, trading, the wealth management story. It's not just driving technology earnings. That's why one stock we haven't covered here was Morgan Stanley, which sits directly at that intersection between capital markets and wealth management trends. That was interesting enough to warrant a deep dive in this week's Magic Markets Premium report.
Without giving away the juice of the report, I think it's important to look beyond whether it's produced a good quarter at Morgan Stanley versus this question around whether the wealth-heavy model genuinely reduces earnings volatility, or if it's just repackaging risk and market exposure through asset values and client flows, and most importantly, whether the current valuation already reflects that quality.
For those of you interested, the full investment case, including the valuation and risks, is available for subscribers in our Premium report this week. And if you aren't already a subscriber, it's only R99 a month. Go and check that out at magic-markets.com. Let us know your thoughts.
Ghost, I think we've unpacked a lot in a very interesting sector of the markets, and that's where we're going to have to leave the show this week. Let us know what you thought of the show. Hit us up on social media.
It’s @MagicMarketsPod, @FinanceGhost and @MohammedNalla, all on X, or go find us on LinkedIn. Pop us a note on there.
Until next week – same time, same place. Thanks, and cheers.
The Finance Ghost: Ciao.
