I love the American market. Apart from groovy stock market tickers (like NYSE: RACE for Ferrari), the market is kept up to date by quarterly earnings releases from the best-known companies in the world.

The Q3 earnings season is upon us, as companies report on how they did from July to September. You don’t have to wait long for information in the US either, since the quarter ended just two weeks ago.

Bankers caused the last global crisis in 2008 / 2009, so let’s look at how they’ve done in the first quarter of relaxed lockdown rules after a crisis that they didn’t cause.

They think the worst is behind us

The leading banks in the US all determined that lower credit loss provisions would suffice. This is in comparison to the provision percentages that were applied in the last two quarters at the height of the economic disaster.

Still, it’s a strong signal to the market that bankers believe things are looking up from here. Bankers also once believed that house prices would go up forever, so perhaps this should be taken with a pinch of salt.

Lower interest rates and decreased consumer spending are painful for banks

Banks want you to spend money and they especially want you to do it on credit, preferably at nice juicy interest rates.

Not only have consumers had less money in recent months, but they had fewer spending options. One could only get excited so many times about buying the most expensive things at the grocery store to make up for no social life.

Low interest rates aren’t good news for banks because endowment income decreases. Like any company, a bank is funded by a mix of debt and equity. The debt includes deposits from bank customers, along with wholesale funding raised in the market. This carries a cost for the bank.

When rates drop, the bank’s income drops but so does the cost of funding. It’s never a perfect hedge, but there’s definitely an offsetting effect.

Equity, on the other hand, carries no cost for the bank because the bank doesn’t pay interest on its retained profits. The bank is lending out its equity and so when rates drop, the income drops and there is no offsetting reduction in costs. This income from lending out the bank’s equity is known as endowment income.

Finally, a general drop in spending means the loan book shrinks. The bank has the same expenses as before but has less money out on loan to customers. This severely impacts profitability.

It’s equivalent to owning a shop that fewer people are now visiting. The overheads are there, but the revenue isn’t.

US bank results: a mixed bag

Bank of America missed analyst estimates slightly, posting revenue of $20.45bn for the quarter.

Revenue in the core banking business fell 17%. The global markets side of the business only grew 4%, a pedestrian performance relative to the likes of Goldman Sachs (29%), JP Morgan (30%) and Citigroup (16%).

Goldman Sachs is an investment banking and trading-heavy bank, so the pandemic and associated volatility was good news for a business that thrives in an active market.

Fixed income trading did particularly well, up 49%.

The bank smashed analyst expectations for earnings per share of $5.53, posting a record $9.68 instead.

Wells Fargo has a CEO who is a year into the job and has faced a career-defining crisis in the form of the pandemic.

He came in to turn the bank around after a scandal in which sales-incentivised bank employees opened accounts in the names of actual customers without their knowledge or consent. The fraud went public in 2016 and Wells Fargo found itself in court for four years, settling in February for $3bn.

Other than repairing the reputation, the goal is to cut $10bn off annual expenses. An increase in expenses in Q3 came as a surprise to the market but was attributed to once-off restructuring and customer remediation charges. Wells Fargo posted revenue of $18.9bn but saw profit shrink 56% to $2.04bn.

Citigroup posted revenue of $17.3bn, 7% down on the comparable quarter in 2019. Net profit was hit badly, dropping 35%. It’s a poor result from the third biggest bank in America.

The fixed income business was a silver lining in the results, up 18%. The equities business grew 15% which also helped, although the fixed income business is much larger. This wasn’t enough to offset the 13% drop in the global consumer banking segment.

It tops off a poor month for Citigroup in which they were fined $400 million for generally poor risk management and compliance policies. With the fine only issued in October, it’s not a happy start to Q4.

Finally, JP Morgan as the largest bank in the US managed to beat estimates (earnings per share $2.23) significantly, posting earnings of $2.92 per share.

The CFO noted that they expect a 9.5% US unemployment rate in the fourth quarter, vs. the previous expectation of 11%. This echoes the general feeling among these banks that prospects are looking up.

Before you think Citigroup is alone in dealing with huge fines, JP Morgan has received a $920 million fine for manipulating global markets. The legal costs alone for this were $524 million, bigger than the entire Citigroup fine!

Banking continues to lag tech

One thing is clear: tech showed banking the door this year.

The KBW Bank Index, which tracks 24 of the most important financial companies in the US, is down -32% this year. The Nasdaq-100 Tech Index is up 23%.

Tech 1 – 0 Banking

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