Big banks are making more — but they're spending more, too

Banks are already paying billions of dollars to retain their workers — and analysts say the Federal Reserve’s inflation-fighting activities will exert even more pressure on banks this year.

Higher operating expenses are taking a bite out of bank earnings as Wall Street tries to game out what the coming year looks like for the industry amidst a backdrop of rising inflation, competition for talent and less easy money from the Federal Reserve. 

JPMorgan Chase, the biggest U.S. bank by market cap and also the first of the industry’s giants to report quarterly earnings, beat Wall Street revenue expectations last week but revealed an 11 percent jump in expenses, which the bank attributed to the need to pay workers more. While Chase’s $3.33 per share topped earnings estimates, it did so based on the strength of a $1.8 billion release of loan loss reserves (money the bank set aside in anticipation of debt defaults that never took place).

Bank of America and Morgan Stanley were the last of the “big six” banks to report. On Wednesday, Bank of America easily beat Wall Street expectations, and Morgan Stanley posted better-than-expected profits, having kept expenses in line. 

Analysts said they weren’t entirely surprised at the pattern taking shape among the banking bellwethers. “We’re going to be expecting more cost pressures,” said David Wagner, portfolio manager at Aptus Capital Advisors. “That’s a commonality amongst all of those right now.” 

As a rule of thumb, higher interest rates are good for banks with a lot of deposits, because they have more wiggle room to increase profits on lending.

While shareholders punished Chase stock in response, CEO Jamie Dimon sounded a generally optimistic tone in his release. “The economy continues to do quite well despite headwinds related to the omicron variant, inflation and supply chain bottlenecks,” he said, adding that the environment for credit is good. 

“My initial reaction is the earnings report from JPMorgan was way more bullish for the U.S. economy at large than the bank shareholders,” said Jamie Cox, managing partner for Harris Financial Group, noting that the bank still beat expectations. “It just wasn’t as stellar as JPMorgan tends to produce,” he said. 

Citigroup came in shy of analysts’ expectations and cited higher expenses for the quarter, while Wells Fargo seemed to shake off the scandals that have weighed on its public image and bottom line with a solidly upbeat report. Wells Fargo executives also noted, though, the same trend of rising compensation. And like Chase, Wells Fargo’s numbers were given a boost by its release of $875 million in loan loss reserves. Investment banking heavyweight Goldman Sachs also reported higher revenue but missed analysts’ estimates, pushing shares down by as much as 7 percent. 

“I think the impact of inflationary pressure in the economy are hurting the expenses outlook, which appears to be driven by pressures in wages, compensation and benefits,” said James Shanahan, senior equity research analyst at Edward Jones.  

“I think the first quarter is always a challenge. I don’t think the margin improvement happens until the Fed raises rates,” said Chris Marinac, director of research at Janney Montgomery Scott.

As a rule of thumb, higher interest rates are good for banks with a lot of deposits, because they have more wiggle room to increase profits on lending, while banks that rely more on trading and investment to grow their bottom lines could take a hit. Wells Fargo, for instance, has a significant footprint in consumer banking that analysts expect will serve as a tailwind as interest rates rise. 

“The net interest income picture is much more encouraging, given the evidence for tangible loan growth and rate hikes,” Wagner said. “A better, more sloping yield curve is going to benefit banks’ income statements from a profitability standpoint.”

The sweet spot for banks, Cox said, is when short-term interest rates remain low while long-term rates rise. “That spread will be very beneficial to bank earnings,” he said, since banks generally borrow at the lower, short-term rate and lend money at higher rates. 

As such, analysts say that the speed and scope of the Fed’s inflation-fighting activities will exert a considerable pull on bank balance sheets this year.

“I think the Fed policy shift this year is going to be a question of timing. If you have two hikes this year it’s positive, but not as positive,” Marinac said. For instance, if the Fed does not adopt three or four rate hikes, as some observers think they will, then the boost banks get from higher interest rates will be muted. “They showed kind of a slow start the last time. They may not want to take rates up that quickly. That timing is critical for banks,” he said.

Marinac added that even though the Fed is tapering its pandemic-era program of asset purchases, it has stayed mum on what, if any, plans it will undertake to shrink its balance sheet. This means that, for the time being, capital markets can still benefit from the accommodation that nearly two years’ worth of bond-buying has funneled into the economy.

“I think this year could be a very good year, because the economy is strong and you still have all this liquidity,” he said.