Citigroup (C), JPMorgan (JPM), Bank of America (BAC), and Goldman Sachs (GS) are all fresh off earnings with the highly disruptive COVID-19 backdrop still festering. The headline numbers were fantastic with beats on both the top and bottom line for Citigroup, JPMorgan, and Goldman Sachs, with Back of America missing on top-line revenue but beating on bottom-line profit. Big banks are evolving to the COVID-19 landscape domestically and abroad despite the possibility of widespread loan defaults, liquidity issues, ballooning credit card debt, and stressed mortgages. To exacerbate these COVID-19 impacts, interest rates, Federal Reserve actions, yield curve inversion, and liquidity are critical elements.
The business’s customer side continues to be problematic as the pandemic’s duration continues to drag on with no signs of slowing. A segment of the consumer base is faced with lost wages and the real possibility of not meeting their financial obligations, which will unquestionably have a negative impact on revenue and earnings. Capital preservation is now at the forefront, with share buybacks being halted and dividend payouts arrested. Large capital reserves have been put aside for anticipated financial challenges. The big banks have demonstrated their ability to evolve in the face of COVID-19 and present compelling value.
Post Financial Crisis – Big Banks Prepared
The big banks are far stronger and more prepared than they were during the 2008 Financial Crisis and have rigorous annual stress tests that maintain fiscal discipline. Banks are well capitalized and working with clients and consumers on payment deferrals if impacted by the pandemic. With Federal Reserve working in-hand with the banks, a financial bridge to those businesses and consumers negatively impacted by COVID-19 as a stop-gap measure has been afforded. As this pandemic becomes more under control and economic activity rebounds, the banks currently present value at these oversold and depressed levels. Citigroup (C), JPMorgan (JPM), Bank of America (BAC), and Goldman Sachs (GS) have lost a significant amount of market capitalization as a result of the COVID-19 impact and present compelling investment opportunities. Their strong cash positions and healthy balance sheets allow dividends to continue as the economy transitions through the pandemic’s damage.
Most Recent Annual Stress Tests
The Federal Reserve put new restrictions on the banking sector after the results from the annual stress test found that several banks could get too close to minimum capital levels in potential scenarios tied to the pandemic. The largest banking institutions will be required to suspend share buybacks and arrest dividend payments at their current level for likely the remainder of the year. For the first time in the 10 year history of these stress tests, banks are now required to resubmit their payout plans again later this year. This move is indicative of the unique and unprecedented landscape of the COVID-19 pandemic.
The biggest banks already said they would voluntarily suspend share repurchases, which made up roughly 70% of the industry’s capital payouts. Worst case scenario modeling puts the unemployment level peaking up to 19.5% and could result in up to $700 billion in loan losses for the 34 banks that take part in the annual stress tests. The industry’s aggregate capital ratios could fall from 12% at the end of 2019 to as low as 7.7%. This necessary capital is defined as the difference between a bank’s assets and liabilities, which serves as a buffer to absorb these potential losses.
Banks Prior To COVID-19
The annual stress test in 2019 came back overwhelmingly positive for the financial cohort. Eighteen of the biggest institutions operating in the U.S. had to show they can survive an economic downturn while maintaining the ability to make loans and continue paying out dividends. That hinges on a bank’s capital. Every bank won approval to boost shareholder payouts under the capital plans they submitted. The results collectively showed a resilient banking industry compared to the financial crisis a decade ago, when the government had to bail out lenders. The banks have more than doubled the capital it has to absorb losses to about $800 billion, per the Federal Reserve.
The big banks, specifically Citigroup (C), JPMorgan (JPM), Bank of America (BAC), and Goldman Sachs (GS), were coming off of record profits and revenue across the board. All of these solid numbers from the big banks were expected to continue until COVID-19 hit. Based on the aforementioned stress test results, the Federal Reserve is committed to having a healthy and robust banking industry to support a variety of economic scenarios given the COVID-19 backdrop.
The COVID-19 pandemic has undoubtedly had a negative impact on economic activity worldwide. COVID-19 has ushered in the real possibility of widespread loan defaults, liquidity issues, ballooning credit card debt, and stressed mortgages. Despite this overwhelmingly negative backdrop, massive fiscal and monetary stimulus is being adopted quickly to blunt this economic fallout that amounts to trillions in total stimulus. The banks are far stronger than they were during the 2008 Financial Crisis and have rigorous annual stress tests to show they can survive an economic downturn while maintaining the ability to make loans and continue paying out dividends. Dividends are being held steady, and share buybacks have been discontinued across the board to maintain healthy balance sheets. Some of the biggest banks, specifically Citigroup (C), JPMorgan (JPM), Bank of America (BAC), and Goldman Sachs (GS), were coming off of record profits and record revenue across the board prior to COVID-19. The banks are much more resilient and capitalized with unprecedented government stimulus coming into the fold. As the economy slowly reopens, these banks will likely appreciate higher and retrace previous highs while maintaining their dividend payouts. Many of the banks present compelling investment opportunities at these depressed levels.
Disclosure: holds shares in AAL, AAPL, AMC, AMZN, AXP, DIA, GOOGL, JPM, KSS, MSFT, QQQ, SPY and USO. He may engage in options trading in any of the underlying securities. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses. The author is the founder of www.stockoptionsdad.com where options are a bet on where stocks won’t go, not where they will. Where high probability options trading for consistent income and risk mitigation thrives in both bull and bear markets. For more engaging, short duration options based content, visit stockoptionsdad’s YouTube channel.