What Have We Learned From Bank Earnings?

Key Takeaways

• Big banks, along with all banks, are running into a little bit of a headwind in terms of it being a little more expensive for them to attract deposits, which is good for us as savers—not as good for bank profits.
• The worst-case scenario doesn’t seem to have played out, thanks to the Fed’s efforts in particular. One of the big questions out there is going to be the regulatory outlook.
• It looks like the pressures that we’re seeing on banks are manageable. They’re going to have some headwinds when it comes to profits.

Ivanna Hampton: The banking crisis shocked the sector. Worries have grown since March about whether regional banks would see a big drop in deposits or loan income. Several of them have reported their first-quarter earnings. Morningstar, Inc.’s Chief Markets Editor and Smart Investor Newsletter Editor, Tom Lauricella, is here to talk about the results.

Hi, Tom.

Tom Lauricella: Glad to be here today.

Hampton: So, let’s start with the big banks. Expectations were that the biggest names would be OK when it came to the deposits. What was their story?

Lauricella: That’s pretty much how it played out. That was the expectation going in from broadly across Wall Street and from our banking analyst, Eric Compton, and others on the on the team that the big banks should be in pretty good shape. The big question out there was around whether banks are going to be able to hold on to their deposits, which was the big problem that we saw with Silicon Valley Bank when their deposits fled. It didn’t seem like that was going to be an issue for the big banks—J.P. Morgan, Bank of America, Wells Fargo. That was the expectation that it wouldn’t be a problem, and that’s pretty much how it turned out. Big banks, along with all banks, are running into a little bit of a headwind in terms of it being a little more expensive for them to attract deposits, which is good for us as savers, not as good for bank profits. So, we had some headwinds for the big banks there. But in general, no real change to the outlook for the big banks. They seem to be weathering this crisis as expected in pretty decent shape.

Hampton: But how about the regional banks? I mean, that was the real worry, right?

Lauricella: Yeah, that was the question mark. So, the real question mark was, What was it going to look like at some of these other regional banks, some of which are pretty big? And the question was, Would we see a significant deposit flight from those regional banks like we saw with Silicon Valley Bank? And the answer is mixed. But in general, everything looks to be manageable. So, earnings are under pressure. But overall, it’s largely as expected, and some banks have held up better than others, but really no signs of that big deposit flight that people were worried about. In part, that suggests that the Fed’s efforts were effective. So, that’s good news. Earnings are under pressure. Again, it’s costing more money for these banks to bring in savers and deposits, and that’s affecting their earnings potential. But the real important news is that it came in pretty much as expected, and in Wall Street, as expected is good.

Hampton: It sounds like the worst-case scenarios haven’t played out. But are the worries over for regional banks?

Lauricella: The worst-case scenario doesn’t seem to have played out, thanks to the Fed’s efforts in particular. The worries are not over. One of the big questions out there is going to be the regulatory outlook. There’s political pressure and pressure in general to tighten regulation on these regional banks that had been loosened before and to tighten them back up. So, there’s a lot of question marks now about to what degree there’ll be a regulatory crackdown in response to what we’ve seen and how that affects bank profits and the outlook from here. So, we’re not done yet. And of course, we still don’t know what’s going to happen on the interest-rate front. But while the worst seems to have been avoided, this regulatory question could be hanging over the banks for some time.

Hampton: Now you just mentioned interest rates. How might that play into what happens from here around banks?

Lauricella: This is the other part of the equation, and in essence, it’s at the root of what had triggered the problem to begin with. We are at a different stage than we were a year ago when interest rates were rising very sharply. So, now, we’re at a point where it seems that the Fed is almost done raising interest rates. The question out there is whether or not the Fed will be lowering interest rates. Our economist Preston Caldwell expects the Fed to start lowering rates next year. That’s kind of a mixed bag for banks. It will hurt some banks. Their net interest income, as it’s called, on average for most banks, that’s the bad part. But it would also help out some banks that have lost money on their bond investment. So, if the Fed starts to lower rates, that’s good for bonds. And so, these banks that are sitting on these big unrealized losses in their bond holdings from when the Fed raised rates, that could take some of the pressure off the banks. Reversing losses is a good thing, especially if you’re considering some of these regulatory pressures. You could definitely say it’s a mixed bag, but if the Fed does end up lowering rates as we head into next year, that at least should be a little bit of a pressure release.

Hampton: Now, what about bank stocks? I mean, they’ve taken some big losses this year. What should investors be doing?

Lauricella: Across the coverage of banks at Morningstar, analyst Eric Compton, his comments were almost universally that he thinks the markets have gone too far with taking bank stocks down. When he crunches the numbers and when he looks at things, he thinks a lot of these banks, the regional banks in particular, are now pretty undervalued. Now, there’s risks here. I mean, this is not for the faint of heart. There could be other things that pop up, especially if the Fed doesn’t end up lowering interest rates. But right now, for those with the long-term time horizon, a lot of the regional banks in particular are looking particularly attractive based on Eric Compton’s thinking.

Hampton: When we tie it all together, what’s the main takeaway for investors?

Lauricella: The main takeaway at this point is we dodged a bullet. It looks like the pressures that we’re seeing on banks are manageable. They’re going to have some headwinds when it comes to profits. And while there still might be some isolated pockets out there of real problems, things look like they’ve stabilized. The earnings reports are as expected to decent. So, investors can breathe a little bit of a sigh of relief. Now, the only question is, really, we’ll have to see this in coming months, is how does this factor through to the economy in terms of how much banks tighten their lending. But that’s an interview for another day.

Hampton: And you be assured that we’ll be talking about it. Thank you, Tom, for your time today.

Lauricella: Glad to be here.

Hampton: Subscribe to the Smart Investor Newsletter. You can catch up on the weekly rundown of Morningstar’s take on big market trends and investment opportunities. I’m Ivanna Hampton, a senior multimedia editor at Morningstar.