Beaufort Analysis No. 313 – Are the banks in good health?
Last week the biggest US banks reported solid fourth quarter earnings with most improving on the third quarter and beating analysts’ expectations too.
This resulted in both Goldman Sachs and Bank of America’s shares jumping by 9% and 7% respectively on Wednesday. Citigroup’s shares climbed 4% on Monday, Morgan Stanley increased 1% on Thursday and JP Morgan’s stock rose slightly as well on Tuesday.
Despite Wells Fargo beating earnings expectations, it was behind on revenue estimates and it also announced it will have to continue to operate under the Federal Reserve’s growth restrictions for the rest of 2019 (These are restrictions related to the sales malpractice discovered in 2016). As a result, Wells Fargo’s shares fell by nearly 3% on Tuesday.
For 2018 as a whole, these six banks earned USD 120.2 billion in net income. Not only does this dwarf their 2017 earnings, but it also reflects the strength of the US economy and the confidence equity investors have in the US banking sector.
Although these earnings are impressive, as investors we should also be mindful how resilient the sector is as well.
The best way to assess this is to refer to the central banks’ latest stress-test results. Such processes test various potential adverse scenarios to evaluate if the banks can survive and continue to lend if so impacted.
The Federal Reserve conducted the first stress-tests in 2009 and at that time 10 of the 19 banks failed. Since then they have conducted annual stress-tests for both US and foreign banks operating in the US and in 2018 only one bank failed, which was Deutsche Bank’s US division.
The European Central Bank (ECB) started its stress-tests in 2010 and at that time 7 of the 90 banks that were tested failed. In the latest round of ECB stress-tests, reported in November 2018, all of the banks passed.
The Bank Of England’s latest stress-test report, issued in November 2018, also concluded no UK bank failures.
The results for US, UK and European banks do contrast with the stress-tests conducted on Chinese banks, however. In 2017 the IMF conducted tests on 33 Chinese banks and 27 were found at the time to be under-capitalized by at least one measure. The IMF did pass all of China’s biggest 4 banks, however: The Industrial and Commercial Bank of China, China Construction Bank, Bank of China and the Agricultural Bank of China. The People’s Bank of China (PBoC) has subsequently reported in their Financial Stability Report the reliability of the Chinese financial system since 2017. They reported enhancements to the financial system and that financial operations were generally stable now.
We look forward to the IMF’s next Chinese stress-test results but, judging by the unique efforts since 2008, it is reassuring to know that last week’s US banking results are as sound as they are rewarding.
Regarding the main markets last week, it was generally a positive week for risk assets. The FTSE 100 rose 0.7% and GBP rose 0.5% against the USD and also 0.6% against the IMF’s chosen basket of currencies – the XDR. Brent crude increased by 1.7% and gold, a preferred risk-off asset, slipped by 0.5%. The US 2 yr / 10 yr Treasury spread widened by 0.02% which although is a very small amount the recent trend had been a continual narrowing but this small reversal implies the US Treasury market improved its sentiment slightly as well.