The end of an era for bank profits

Oct 11, 2024

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Quick Fix

Markets cheered when Federal Reserve Chair Jerome Powell cut interest rates by half a percentage point last month. Of course, they did! Lower interest rates make it easier to buy a home, pay off a credit card bill, expand your business and, generally speaking, spend money.

But with JPMorgan Chase and Wells Fargo set to kick off the third-quarter earnings report season this morning, it’s important to take a moment to mark how falling rates will also close the curtain on a golden era for bank profits. And oh, what an era it was.

Net interest income, or NII, refers to the difference between the yields banks generate on loans and the interest payments they have to make on deposits. When Powell pushed rates up above 5 percent to combat inflation, it increased the returns that financial institutions could charge for loans.

To the chagrin of depositors, the rates paid to account holders did not always climb in lockstep with the Fed. The end result was a $1 trillion windfall that allowed more than 4,000 banks to “pad out profit margins,” the FT reported.

Top executives at U.S. banks have been warning for months that net interest income would invariably decline once Powell lowered borrowing costs. At least one more cut is projected between now and the end of the year, which means net interest won’t be so rich in the months ahead — more like sirloin than a king cut of prime rib.

JPMorgan and Wells Fargo “have already indicated that lower, short-term interest rates will have an adverse impact on their net interest incomes,” Gerard Cassidy, a large cap bank analyst and Head of US Bank Equity Strategy at RBC Capital Markets, told MM. “A good portion of the earnings calls are going to center around net interest income, net interest margin and the impact of the Fed easing policy on this area.”

The effect on third-quarter earnings will likely be minimal — Powell announced the 50-basis-point reduction with less than two weeks remaining in the third quarter, after all — but bank leaders will be pressed to provide an update on how the rate environment will affect their returns moving forward.

It ain’t all bad, of course. Lower rates will also drive investment and deal-making, which should generate fee revenue. Cheaper credit might also spur more consumers and businesses to take on loans, which would generate additional income as well.

Some deal activity might be on hold until after the election. If the results of the vote are contested, that would weigh on equity markets and likely put some mergers and acquisitions on hold.

“Hopefully, it won't be a significantly contested election,” Cassidy said. “A contested election increases uncertainty which — as a rule of thumb — increases risk.”

IT’S FRIDAY — Looking forward to being back in your inbox on Tuesday. Until then, I’ll be cranking Warren Zevon in bumper-to-bumper traffic on the 405. If you’ve got tips, let me know at ssutton@politico.com.

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Driving the Day

The producer price index will be released at 8:30 a.m. … The consumer sentiment index will be out at 10 a.m. … Dallas Fed President Lorie Logan will participate in a panel at the Federal Home Loan Bank of Dallas’s Women in Financial Services Conference .… Fed Gov. Michelle Bowman will speak before the 18th Annual Community Bankers Symposium hosted by the Federal Reserve Bank of Chicago at 1:10 p.m. .…

Trump’s latest econ pitch — Donald Trump continued to sprint to the left on economic policy on Thursday. Democrats aren’t buying it.

The former president has courted Wall Street with pledges to lower corporate rates and slash regulation. But he’s also courted working class and rank-and-file union voters with a bevy of policies that he says will help working families, including capping interest rates on credit card loans, and eliminating taxes on Social Security benefits and overtime.

In a speech at the Detroit Economic Club on Thursday, he went even further, saying he would make interest payments on car loans fully deductible.

Trump told the Motor City crowd that the deduction would “revolutionize your industry,” your MM host reported with Gavin Bade. “This will stimulate massive domestic auto production and make car ownership dramatically more affordable for millions and millions of working American families.”

The cost of the new policy to the federal government would likely be significant. There’s more than $1.6 trillion in outstanding securitized auto loans, according to Federal Reserve data, and Trump’s economic policies are already projected to add trillions more to deficits than what Vice President Kamala Harris has proposed.

Trump’s policy could effectively restore a deduction that existed before President Ronald Reagan overhauled the tax code in 1986, said Brookings Institution fellow Aaron Klein. It’s also unclear who would benefit, as many subprime borrowers may not itemize their deductions.

The auto loan deduction — coupled with other Trump tax policies like the credit card interest cap — “is a very blunt way of messaging: ‘When I’m president I’ll stand up for you on your behalf,’” Graham Steele, a former Biden Treasury official who’s now an academic fellow at the Rock Center for Corporate Governance at Stanford Law School, told MM. “The way he’s governed has been very different from that.”

Progressive Democrats have been quick to point out that the former president ran a similar playbook in 2016. He proposed raising taxes on carried interest — a political third rail for the private equity industry — and reinstating the 1933 Glass-Steagall law, which would have broken up big banks.

Did any of that happen? No. But Trump’s new collection of populist economic proposals are opening up new policy fronts on the left as Harris courts the center.

“It is far easier to campaign against Trump on social issues, where his views on abortion, racism, and on culture are often out of step with both the left and the country club scene,” said Klein. On economic policy, “he’s running to the left, right and center of her, and up and down.”

Speaking of economic populism…

First in MM: The trouble with ‘no tax on tips’ — Both Harris and Trump say they want to eliminate taxes on tipped income. Trump has also said he’d slash taxes on overtime pay. The end result of those policies would create new forms of tax inequity for workers who make the same amount of money, according to a new analysis from the Budget Lab at Yale.

For some filers, it would “double the current level of inequities in the [tax] code,” wrote John Ricco, the think tank’s associate director of policy analysis. An inequitable system could lead to “loopholes, inefficient tax avoidance and notions of unfairness,” they wrote.

The Economy

The inflation fight — Annual inflation has fallen to 2.4 percent, its slowest pace since early 2021, signaling that the price spikes that have clouded President Joe Biden’s four-year term are over. But it might be too late in the game for Harris to get credit for it, our Victoria Guida reports.

— Inflation was still hotter than some economists anticipated. Fed policymakers were unfazed, write Bloomberg’s Catarina Saraiva and Amara Omeokwe, but Atlanta Fed President Raphael Bostic said a pause might be warranted at the November meeting.

— Don’t miss Victoria’s latest column, on the homepage this morning, about a key ingredient to Harris’ economic policy pitch.

On the Hill

Hagerty produces stablecoin proposal — Trump ally Sen. Bill Hagerty (R-Tenn.) on Thursday released a draft of his proposal to overhaul how the U.S. regulates stablecoins — a type of cryptocurrency pegged to other assets like the U.S. dollar, Jasper Goodman reports.

Hagerty’s office said his bill builds upon an earlier one from House Financial Services Chair Patrick McHenry (R-N.C.). Hagerty’s would give less authority to the Federal Reserve to oversee stablecoins — a key point of tension that has weighed on talks between McHenry and House Financial Services ranking member Maxine Waters (D-Calif.).

“Stablecoins have the potential not only to enhance transactions and payment systems but also to help create new demand for U.S. Treasuries as we work to address our unsustainable deficit,” Hagerty said in a statement.

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Wall Street

First in MM: BlackRock tells FDIC not to worry — The world’s largest asset manager would like the FDIC to know that it’s not exerting any undue control over the banks it invests in, our Declan Harty reports.

In a letter, BlackRock Head of U.S. Regulatory Affairs Benjamin Tecmire told the FDIC earlier this week that the investment giant almost always sides with bank management teams and “does not use engagement as a tool to manage or control a company.” The letter comes as the FDIC dials up its oversight of large asset managers like BlackRock and Vanguard to make sure they are indeed “passive” investors in the banks.

BlackRock owns substantial stakes in 39 bank and savings and loans holding companies that control FDIC-supervised institutions, according to the letter. But BlackRock has voted with management 99.85 percent of the time on proxy items. And as for its engagement efforts, the companies are often the ones asking for the conversations, BlackRock said.

Warren targets PE — Sen. Elizabeth Warren (D-Mass.) reintroduced the Stop Wall Street Looting Act on Thursday, which would make private equity funds and executives liable for any debt, legal judgments and pension-related obligations made against the companies in their portfolio. Another provision would block federal health programs from making payments to health care companies that sell assets to a real estate investment trust.

— Default rates for private equity-owned businesses have spiked since the pandemic. The rate stood at 16.7 percent, compared to just 7.1 percent for non-PE-backed businesses, according to Moody’s Ratings research published on Thursday.

Treasury

First in MM: Treasury unveils new CDFI bond funding: The Biden administration is announcing Friday that it’s guaranteeing $498 million of bonds that’ll allow community development financial institutions to finance housing, charter schools and other projects in low-income communities, Michael Stratford reports.

It’s the largest bond issuance of the CDFI Bond Guarantee Program since its creation in 2010. “Today’s historic announcement will increase their access to capital to help realize projects that expand housing supply, grow small businesses and ensure access to health care and child care,” Treasury Secretary Janet Yellen said in a statement.

Vice President Harris has been the face of the administration’s push to expand capital to underserved communities through CDFIs. On the campaign trail, Harris has proposed a new fund that would allow CDFIs to finance low- or zero-interest loans to small businesses.

SEC sues crypto trader Cumberland DRW — The SEC on Thursday sued Cumberland — a decade-old part of the high-speed trading firm DRW Holdings — for allegedly operating as an unregistered dealer in the more than $2 trillion crypto market since at least March 2018, our Declan Harty reports.

Treasury imposes $3B penalty, asset cap on TD Bank — Treasury officials said Thursday that TD Bank will pay more than $3 billion in penalties and have its assets capped after failing to policy money laundering and drug trafficking, our Michael Stratford reports.

Jobs report

Jim Robnett, a former deputy chief of the criminal investigation division at the Internal Revenue Service, has joined Wave Digital Assets as chief of government operations.

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