Let bank earnings be your guide, investors.
JPMorgan Chase & Co. (JPM) , Citigroup Inc. (C) Wells Fargo & Co. (WFC) and BlackRock Inc. (BLK) reported first-quarter earnings on Thursday and Friday. Here are five things the reports show about the economic impact of President Donald Trump's tax cuts and how the Federal Reserve's interest-rate hikes are affecting consumers.
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1) Taxes Are Already Padding Profits at U.S. Corporations.
Deep cuts in U.S. corporate tax rates, thanks to President Donald Trump's fiscal-stimulus law inked in December, are already serving up a windfall to the big banks - even with less-than-stellar performance in core areas such as loan growth.
To see the impact, just compare the financial companies' pre-tax profit growth in the first quarter with after-tax results. JPMorgan's pre-tax profit climbed by 28% from a year earlier. But net income, after taxes, soared by 35%. At Wells Fargo, pre-tax profit actually declined last quarter by 5%. But thanks to the tax cuts, the bank was able to report a 5% increase in net income.
Aside from simply helping the companies' CEOs look better on paper, the tax bounty represents money that can be paid out to shareholders in the form of fat dividends or stock buybacks -- instead of the government.
BlackRock CEO Larry Fink told investors on a conference call Thursday that corporate executives are already starting to move money around due to the tax cuts -- a phenomenon that can be viewed in flows in and out of the company's various investment funds, which have $6 trillion-plus of assets under management.
"We saw a number of large inflows and a large amount of outflows as clients rebalanced and sought liquidity to either fund future capital allocation or be more aggressive in share repurchases," Fink said. "And we're very well positioned for additional organic growth opportunities related to the prospects of a rising rate environment and as corporations are repatriating their cash related to the U.S. tax reform."
TheStreet's founder Jim Cramer analyzes bank earnings below.
2) Tax Cuts Are Making It Easier for Borrowers to Repay Their Loans -- Another Bonus for Banks.
Bank executives expect Trump's tax cuts to leave borrowers with more cash to repay debts - leading to lower loan losses and, in turn, bigger profits for the banks. That's especially helpful now that the Federal Reserve is raising U.S. interest rates, which increases the cost of floating-rate loan payments while making it more expensive for borrowers to refinance fixed-rate debt when it comes due.
"Across the board, actually, all the way from small business through middle market, we're expecting sort of higher earnings, more free cash flow, and generally speaking that would improve the credit quality of the portfolio," JPMorgan CFO Marianne Lake told investors on a conference call. "No doubt it helps, but it helps in a rising rate environment. There's a lot of plusses and minuses but yes, it's a tailwind for credit overall."
3) Consumers Are Responding to Higher U.S. Interest Rates by Taking Out Fewer Home Loans.
As interest rates rise, refinancing a mortgage becomes a less-attractive option for many existing homeowners, while new-home buyers face less affordable monthly payments on loans for purchases. Yields on 10-year Treasury notes - the key driver of mortgage rates - currently are around 2.8%. But bank executives are starting to worry that a move above 3% could hit mortgage-underwriting profits hard.
In the first quarter, Wells Fargo originated $43 billion of home loans, down from $53 billion in the fourth quarter.
"Businesses like mortgage will do better on the origination front if longer rates remain at about where they are today, versus begin to move above 3%," Wells Fargo CFO John Shrewsberry told investors on a separate conference call. "There's some question about affordability in some markets, and so originations come down."
4) Banks Are Still Pocketing Higher Interest Rates -- Rather Than Passing Them on to Customers.
Rather than pass along higher interest rates to individual savers in the form of higher deposit rates, big banks are mostly pocketing the extra money they collect from rising loan rates. Corporations, on the other hand, are seeing big increases in their deposit rates because banks are so keen to keep them happy as lucrative customers.
The metric to watch is "deposit beta" - essentially the percentage of each Fed rate hike that gets passed along to customers. The higher the number, the better it is for savers; the lower the number, the better it is for bank profits.
John Gerspach, Citigroup's CFO, told investors: "As we continue to get rate increases and the rate increases increase also in frequency, you're going to start to see some pressure on those deposit betas. It's just inevitable, and it's going to happen. Hasn't happened yet."
He added: "I'd say corporate betas have moved up certainly more than consumer betas and that's been consistent at least for the last year. So, you have a mixed component in the beta. Not every beta is the same."
5) Banks Are Mostly Insulated From a Recent Surge in Money-Market Rates; That's Not the Case for Commercial Borrowers Whose Interest Payments Are Tethered to the Rates.
Money-market rates - as measured by the three-month London interbank offered rate, known as Libor - have spiked in recent months as Trump's tax cuts force the U.S. government to borrow more money to plug the widening deficit. The trend has led to a bigger supply of Treasury bills coming to market, forcing the government to pay higher yields to attract additional buyers.
Being in the middle of the financial system as both a borrower and lender of funds, banks' exposure to Libor rates is partly hedged.
"Examples of assets that we price off Libor would be the commercial banking loans and, obviously, unhedged or hedged long-term debt on the liability side," JPMorgan's Lake said on the company's conference call Friday. "If you look sort of net across the assets and liabilities sides, they materially offset."