AUGUST 2 0 2 3 • I S S U E 33

Current State of the Banking Industry

This year has been a tumultuous one for the global banking industry. Problems in the industry kicked off with the collapse of Silicon Valley Bank (SVB), the 16th largest bank in the US, on Friday the 10th of March. Other problems with the likes of Credit Suisse and First Republic dominated headlines in the following weeks and months. Fears of a full-blown banking crisis were feared, but six months on from the collapse of SVB this has seemingly not transpired. Investors will continue to watch key indicators in the industry to determine its health.

Second-quarter earnings have shown the banking industry is performing better than expected following the fallout from events earlier this year. JP Morgan reported revenue of $42.4 billion when $38.96 billion was estimated. In response to its strong earnings report JP Morgan CEO Jamie Dimon stated, “Consumer balance sheets remain healthy, and consumers are spending, albeit a little more slowly. Labour markets have softened somewhat, but job growth remains strong.” This indicates a strong belief that we still find ourselves in a market environment where banks can perform well. Bank of America also performed well with revenue of $25.33 billion vs. an expected $25.05 billion. UBS performed extremely well, reporting a global record for quarterly bank profit of $29 billion.

In the cases of JP Morgan and UBS, these banks have somewhat benefitted from the turmoil in the banking sector earlier this year. Their respective acquisitions of the troubled First Republic Bank and Credit Suisse have had positive impacts on their earnings results. Banks have also benefited from higher interest rates which now seem to be peaking in major global economies. This stems from the ability of banks in such an environment to loan to borrowers at higher interest rates without increasing the rates offered to savers on their deposits.

Despite the positive earnings banks have experienced, some believe this is the best we’ll see for a while as risks do still remain. Banks are expected to continue to feel pressure from losses in areas such as credit cards and commercial real estate. While higher interest rates can benefit bank earnings, they can also mean slowing loan growth, which is currently being seen and presents a further risk to banks. This is illustrated in the figure below.

While risks do remain for the banking sector, in the current market environment, this is true of the market at large. While high interest rates do present risks, they also can have a positive effect on banks as has been seen in recent earnings releases. It is important for investors to continue to monitor key indicators such as loan growth to determine the health of the sector going forward.

Eurozone Update

The economic picture in the Eurozone has been defined by a few key topics this year. Some of the most prevalent topics include inflation, interest rates, and the continued effects of the Russia-Ukraine war on the region. These topics have proven to be key drivers of economic performance in the region and are therefore key for investors to watch.

Preliminary inflation numbers for August show headline inflation remaining at 5.3% year-on-year (YoY) for the month. Preliminary core inflation, which excludes the volatile food and energy prices shows a decline to 5.3% YoY for August from 5.5% previously. In terms of headline inflation, food continues to remain the largest contributor, with preliminary numbers showing prices up 9.8% YoY in August. On the positive front, the Eurozone has managed to bring headline inflation down significantly from its peak of 10.6% in October of 2022. However, core inflation has proven to be much stickier, remaining in the range of 5% to 6% since late 2022, as illustrated by the figure below.

The European Central Bank (ECB) has raised rates by 4.25%, from its rock bottom level of 0%, with nine rate rises since July of 2022. The ECB has continually pushed the narrative of higher rates for longer in order to fight inflation. The ECB will make its next rate decision on September the 14th which does not seem to be a clear-cut decision. Analysts believe there is a 30% chance of a 25-basis point rate hike with a pause seemingly more likely. Going forward the ECB will be expected to make their decisions based on whether the data shows that the rate hikes already implemented have a significant impact on bringing inflation down or not.

Russia’s invasion of Ukraine in February of 2022 increased fears that the Eurozone would enter a recession. A large portion of this fear was due to the region's reliance on Russia for its energy supply. However, after about a year and a half has passed, the Eurozone has dealt with this better than expected, successfully managing to secure alternative energy supplies.

The Eurozone grew by 3.5% in 2022, with growth of 0.8% expected for the current year and 1.4% expected for 2024. Whilst growth is expected to slow the general feeling is that this is still solid performance considering the challenges the region has faced in recent times.

Considering these challenges it is also important to note that equity valuations have become attractive in the region in recent times, and while this does not guarantee upward growth it is important for investors to monitor the market for catalysts that could spark this.