Jeff Davis, CFA, is a veteranbank analyst. The views and opinions expressed in this piece are those of theauthor and do not necessarily represent the views of S&P Global MarketIntelligence or Mercer Capital, where he is the managing director of thefinancial institutions group.
Inthe larger scheme of the U.S. economy and our capital markets as a vehicle toefficiently allocate capital, the 90-day earnings cycle means little, in myview. I am not sure how it happened, but over the past 25 years, quarterlyearnings reports evolved into an elaborate game orchestrated by Wall Street andplayed by publicly traded companies regarding expectations, variances andrevised expectations to be repeated in 90 days. I should add Microsoft has madeone decided positive contribution to quarterly reports: the PowerPointpresentation that graphically summarizes results and trends that are describedin a Microsoft Word document that sometimes has a Microsoft Excel attachment.Most of the Street likes a lot of detail; PowerPoint facilitates quickabsorption of it.
Whetherthe reports are elaborate or brief, I think banks will live up to the billingthis quarter that they are supposed to be boring. Little changes quarter toquarter for most businesses, absent an industry or broader economic inflection.It does not seem like the U.S. economy is at a decided inflection point, thoughthere are signs the current cycle is in the mid-to-late innings beforeconsidering central-bank-engineered extra innings.
Amuch-discussed recent data point is the slowdown in commercial loan growth. TheFed's H.8 report indicates C&I loan growth stalled this summer afterseveral years of strong growth. The slowdown corresponds with several banksguiding investors to the low end of their loan guidance range in the pastcouple of months. Also, Thomson Reuters reports that syndicated loanoriginations fell 38% to $372 billion, which consisted of an approximate 50%drop in investment-grade loans and a 14% reduction in leveraged loans.
Stallingcommercial loan growth could imply a similar conclusion about the economy ormaybe concern about the election as businesses await the outcome. Or maybe theslowdown is explained by liquidity flows — the ultimate arbiter for markets inthe short run. My take is that commercial loan growth, as measured by loansparked on bank balance sheets, benefited during the fourth quarter of 2015 andthe first quarter of 2016, when high-yield credit markets froze due to wideningcredit spreads as fears about collapsing energy prices and multiple rate hikesincorrectly telegraphed by the Fed caused investors to withdraw capital.JPMorgan Chase &Co., CitigroupInc. and other universal banks that can easily toggle borrowersbetween loans and debt issuances may have bridged client needs withon-balance-sheet financing. The WallStreet Journal ran an articlerecently that detailed how JPMorgan bought a private-placement bond issuance bythe junk-rated Chicago school system when buyers were scarce. JPMorgan agreedto hold the issuance for six weeks while the issuer got its ducks in a row.Markets wax and wane. The bank took credit and liquidity risk as a lender andmade good money on a rebound in prices when the bonds were resold at a higherprice, though the underlying tone of the article was that their hands weredirty for profiting. If the market had tanked, JPMorgan would have become aninvestor or absorbed the loss if it had sold the bonds.
Thesame phenomenon may explain some of the slowdown in commercial loan growth,rather than a Zero Hedge narrative that the economy is collapsing.Leveraged-loan and high-yield-bond markets have reopened since earlier thisyear as liquidity flowed back into the sector. Low prices (i.e., wide spreads)are the cure for illiquid markets. Higher prospective returns attract capital.High-yield bond prices have rallied such that the option-adjusted spread on theBofA Merrill Lynch High Yield index narrowed to 497 basis points as of Sept.30, compared to 887 basis points on Feb. 11 at the height of the panic andaround 670 basis points a year ago. Perhaps part of the disappointingcommercial loan growth story can be explained by treasurers terming-outshort-term bank borrowings in the bond market.
Likewise,auto loan growth credit may prove to be disappointing; however, after theopening of spigots to subprime borrowers for a few years,"disappointing" volumes during the second half of 2016 andprospectively next year may not reflect economic weakness so much as lenderscoming to their senses. After all, subprime infers nothing about character buta lot about ability to repay a loan.
Nordo I think investors will get much of a read on the perpetual 800-pound gorillain the room, as relates to community and regional banks: commercial realestate. As an illiquid asset that can masquerade as having a semblance ofliquidity when packaged in CMBS or as the object of desire of institutionalinvestors in a low rate environment, CRE has a propensity to blow up banks.Other than high-end condo projects in places like New York, Miami andapparently Vancouver, it does not seem as though investors are going to getmuch of a read on the sector beyond management teams professing they areclosely monitoring CRE fundamentals.
Asfor the rate environment, the narrative at the margin may be better thanexpected. Technical issues related to new money-market rules contributed to anincrease in the 30-day LIBOR of about 5 basis points between June 30 and Sept.30. And, of course, the Fed has given investors hope that another 25-basis-pointincrease may be forthcoming in December. The potential overlay ofbetter-than-expected NIMs with renewed cost-cutting efforts and rising oilprices may be sufficient to produce upside earnings surprises for , and similarlysituated banks.
Otherbusiness units should perform OK, too. Rising equity and debt markets arehelpful to trust and asset management units. The drop in the yield of the10-year U.S. Treasury during July should be constructive for mortgage bankinggain on sale margins and origination volumes. Likewise, 's results for thequarter ended Aug. 31 imply subdued capital market and investment bankingrevenues, but no disaster.
Insum, third-quarter results should be a snoozer. Another apocalypse has beenavoided until the next 90-day reporting season, though perhaps the morerelevant questions are: How long can central banks continue to prop up assetvalues? And is DeutscheBank's liquidity and capital position akin to Bear Stearns' andLehman Brothers' weakened positions in 2007, only multiples bigger?