Back in 1967, there was a Danish variety show featuring a song called The Swings and The Carousels. The chorus ran along the lines of:
We need to earn on the swings
What we lost on the carousels
Referring to the old amusement park, Tivoli, in Copenhagen, it is basically a lesson in how diversification can lower risk. That is also the story from the second quarter earnings reports from the largest banks.
Revenue from investment banking (the swings) is booming—with a better outlook companies want to go public again and they want to do it with “real” banks. JPMorgan Chase is almost 50% up in that department compared to last year and Goldman Sachs is right behind it.
Consumer lending (the carousels), however, not so much. The heavy banks in that space, Wells Fargo and Bank of America, show serious pressure on their net interest income and it might last for a while longer.
Savings accounts that pay nothing are out of fashion, which for the banks means more expensive funding on a shrinking base. And with interest rates having peaked, but still being high, the banks have little hope of being able to collect more on loans going forward.
At the same time the credit quality of the existing loan books is in decline, which is just a fancy way of saying that more people carry credit card balances over from month to month, more fall behind on payments, and to add another red flag, more lower-income consumers are using their credit cards for necessities such as groceries and gas.
Just as it has taken some time for the pain to be felt, it will take some time for it to subside. Inflation is only starting to come down, and the Fed has yet to make the first rate cut, although they seem to be thinking about it more than ever.
Everything takes time to make its way through the economy.
That could make it a bit of a rollercoaster ride for the banks. To paraphrase WSJ this week; drip-wise, small rate cuts might not grow loans fast enough to offset the immediate effects of lower rates on income from floating-rate loans, such as credit cards.
And the deposits that left the banks for better places are probably not in a hurry to come back without some incentive.
What saves the largest banks is their diversification. Most of them have investment banking and wealth management on their menu to make up for losses on the consumer lending side.
The regional banks, which often rely on carousels, have had to follow a different strategy, namely shed their riskiest loans, either by sale or charge-off. Many of them have gotten rid of commercial real estate loans, and it seemed to have worked because overall their net interest income is widening again.
It remains to be seen whether it is truly past the bottom of the ride, or if there will be more unpleasant surprises from the credit card statements in the coming quarters.
Feeling seasick anybody?
Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.