A second full week of bank earnings reports confirmed earlier trends. In a stark reminder that markets are only semi-efficient, the resulting bank stock rally is the strongest single month return as measured over 319 months since 1998. The Nasdaq BANK index is 66% higher from the May 4, 2023 close. A second report on June inflation data supported the earlier CPI findings. Despite restrictive monetary policy, the U.S. economy continued to expand in the 2nd quarter at a 2.8% annualized rate. Consensus expectations are for no policy change at this coming Wednesday’s Fed meeting.
Larger bank earnings reports have mostly now been released. For banks larger than $10B in assets, 77% beat EPS expectations in the quarter by a median 4.7%. Across the group, 76.0% reported sequentially higher Net Interest Income and 65.6% reported higher Net Interest Margin as asset repricing finally outpaced increases in funding costs. The other key metrics mostly held steady from last week’s interim numbers. Notably, the sequential provision increase was more muted as more regional and community bank results were included in averages. Median capital ratios and allowance coverage ratios improved.
Also confirmed by this second week of results, median sequential EPS will grow for the first time since 2022. The favorable trend of asset repricing and stable funding costs should continue into the 2nd half. However, most banks retain some level of asset sensitivity such that Fed rate cuts will temporarily be a net income headwind. Although few banks see material changes in client behavior materializing until short end rates are a point of more below today’s level.
July bank stock performance has been historic. Indices such as the Nasdaq BANK Index are sitting on their best monthly gain in decades. The previous best month since 1998 for the BANK index was November 2016 coinciding with Trump’s surprise presidential election victory.
From a valuation perspective, the increase in bank equity prices makes the group very fully valued in my opinion. My primary sector valuation tool is Equity Risk Premium (ERP). The mid-cap bank ERP spread has fallen to just 3.17% which compares to more than 7% last September. When I consider variable changes in 2025 that would leave me optimistic for further bank stock upside, I find something in the range of 20% EPS growth and a lower risk free rate down to 3.5% being needed. I assign a low probability to both of these scenarios.
Switching to consumer inflation, the June PCE data from BEA (July 26) left the 6-month annualized core PCE rate flat from May. Since the January 2024 core PCE increase was 0.5%, if I assume a July monthly rate of 0.2%, the 6-month annualized rate would drop back below 3% to 2.8%. February through April readings of 0.3% would continue to roll-off and presumably be replaced by lower increases ahead of future Fed meetings in the second half of 2024.
This week’s selection of earnings call quotes highlight statements for which my take away was probably different than what the speaker intended. When you participate in a hundred calls or so each quarter, patterns become observable. For example, if similar actions are being taken across a thousand banks, not everyone will be taking share and winning clients with their “innovative†new deposit gathering teams. Lake Wobegon is a fiction.
SASR CEO Dan Schrider noted, “some initiatives we had in reaching into the new clients that we attracted through our high-yield savings account. And we developed some products for that segment hasn’t hit the ground as well as we had expected. So we’re tweaking the products as well as the promotion to get more success in turning those into full banking relationships.â€
Is it realistic to expect rate promotional deposit gathering to turn into full banking relationships?
EFSC Chief Credit Officer Douglas Bauche stated, “We saw in the second quarter a migration of about 8 or 10 relationships from pass rating into special mention — no real commonalities there though. We saw companies that range from commercial roofing contractors to health care service providers to importers of apparel. But no real common trends and no real concerns about really the overall health of the portfolio. So these were migrations in risk ratings due to the collection of the fiscal year end ’23 numbers and first quarter 2024 numbers where there’s just some impairment in cash flow temporary or liquidity, but I think appropriate plans in place to see these improve in the quarters to come.
Is nearly a dozen C&I clients across a range of industries experiencing cash flow or liquidity impairment an early sign of systemic problems? Exactly when does recurring idiosyncratic cross into systemic?
FFWM CFO Jamie Britton highlighted, “First Foundation’s success is certainly a result of its people, and Chris’ sentiment couldn’t be a better way to kick off a discussion of the capital raise and where we see the company going from here. Because importantly, we value the culture our team has built and nurtured over the years, and we believe our focus on customer experience, providing a holistic set of banking options and leaning into our expertise to help build our bank and support our communities have been foundational to our success. Rather than using the capital raise as an inflection point to focus on new businesses or materially change our old, we hope to use it as an opportunity to get back to what we do best, leading with our people and sharing with our markets the hallmarks that have made First Foundation such a valued partner to our clients and a trusted steward of our shareholders’ capital.
How does doubling the share count while diluting 7-years of book value demonstrate being a “trusted steward†of shareholder capital? I’m thinking about creating a measure of the number of times words like “successâ€, “confident†and “proud†are used over a call. My thinking is that the greater the usage is indicative of a higher degree of desperation. Platitudes and pablum have relatively little value from an investment perspective and seemed to be used as a substitute when actual results are wanting. During their call, First Foundation told us about success/confidence/pride 18 times.