The countdown is on. Earnings season is set to kick off Friday with the banks, one of ours among them. The whole sector came under heavy pressure last month after the collapse of Silicon Valley Bank. How the banks deliver could set the market tone in the coming weeks. Much of this mini-banking crisis ties back to the Federal Reserve’s war on inflation, with the rapid rise in interest rates pressuring loan values and increasing competition for deposits. Central bankers are not solely at fault for what happened at SVB on March 10 as management there was clearly out to lunch. But many economists feel the Fed does share some blame for keeping money so cheap for so long coming out of the Covid pandemic and subsequently having little choice but to hike interest rates at a breakneck speed to thwart spiraling prices. Currently, another quarter-point rate hike is widely expected at the Fed’s May meeting. However, there’s a growing minority who believe the recent banking stumbles should keep the Fed on hold. Jim said Monday that such a pause could spark a big stock market rally while keeping rates high enough for banks to make money. But, first things first. Ahead of Friday’s bank reports, which include first-quarter numbers from Club holding Wells Fargo (WFC), we’re watching three main things: the mix of deposits and loans and the resulting money made on the difference in the form of net interest margin (NIM). How these dynamics play out will factor into the Fed’s next rate move — and as a result, market sentiment. Deposits The chilling effect of the Silicon Valley Bank failure has been palpable. As highlighted by Jim Cramer in his Sunday column , total U.S. commercial banking deposits dropped by nearly $65 billion on a seasonally adjusted basis for the week ended March 29 , nearly three weeks out from SVB’s failure. That’s 10 straight weekly declines , according to bank assets and liabilities data from the Fed. It’s a harsh reminder that accounts in excess of $250,000 are not protected by the FDIC (Federal Deposit Insurance Corporation). Not to mention, withdrawing money without warning has never been as frictionless as it is today — thanks to online and mobile banking. (It’s worth noting the government has backed all deposits at failed banks and has said it stands ready to help elsewhere if needed.) Since deposit levels directly contribute to a bank’s ability to make loans, it’s not surprising that commercial bank lending declined in recent weeks. While the roughly $45 billion drop for the week ended March 29 was less than the $60 billion decline the prior week, it was still indicative of financial tightening. Focusing on deposits at the major banks when they issue their quarters — specifically Wells Fargo, which we think is reasonable to believe saw inflows during the tumult— will signal their overall health and whether they’re in a position to ease up or lock down lending standards. Lending As a result of the sub-optimal deposit situation, lending is taking a hit because banks must maintain certain capital levels. To put a finer point on the bank lending slowdown, Bloomberg looked at the roughly $105 billion decline from the week ended March 15 to March 29 and found it was the largest two-week drop since the central bank started tracking these figures in 1973. That’s a double-edged sword. If money is harder to come by, then anything purchased with a loan such as a car or a home is going to see demand fall. That, in turn, can put pressure on the broader U.S. economy, two-thirds of which is fueled by consumer spending. Again, it’s the kind of slowdown the Fed has been trying to engineer but not at the expense of further hurting the banks just as the sector started to find its footing since the SVB-driven debacle. It could be that we’ve seen all the financial institution tightening that we need to see given that on a seasonally adjusted basis, the average residual (assets minus liabilities) across all U.S. commercial banks in March is on par with the average we saw in February before SVB blew up. However, that’s going to depend largely on deposit dynamics, which rely on confidence in the banking system and how competitive savings account rates are in comparison to high-yielding short-term CDs, money markets or Treasurys. Net interest margin The difference between what a bank pays depositors in interest compared to what they charge customers for loans determines its net interest margin, also known as NIM. Banks generate interest income by borrowing at a lower rate (think deposits/liabilities) and lending at a higher rate (think home mortgages/assets). They have the flexibility to some extent, based on market forces, to tweak that equation. They could always incentivize deposits by raising the rates they’re willing to pay account holders to prevent them from bolting. But in doing so they would have to accept a smaller profit. Wall Street hates that. On the flip side, to protect NIM and net interest income (NII) in a tighter banking environment, financial institutions may have to keep deposit rates relatively low versus alternatives — which means deposits are harder to come by — or raise the rates they charge on loans, making them less affordable and negatively impacting demand for the goods purchased with those loans. Bottom line This is obviously a tough setup for the banks and makes them difficult to invest in. As a result, the reason we are in Wells Fargo has less to do with the operating environment and more to do with it being a self-help story with turnaround catalysts in the form of achieving regulatory milestones. To be sure, Wells is a traditional bank that must deal with short-term deposit and lending gyrations. But we think it’s pretty solid from the deposit side — and by virtue of its higher capital controls, it can’t go crazy giving out loans. As for Club holding Morgan Stanley (MS), which reports its quarter next week, we value management’s focus on fee-based wealth management revenue and investment banking operations. Given this setup, we are comfortable with our slightly greater than 7% cash position in the Club portfolio, believing that a Fed pause would cause a rally. On the other hand, a more dogmatic Fed would prove harsh for the market overall but benefit the tech sector, which is still working through cost cuts and can put still put out growth against a slowing economy. Once again, it comes down to owning a diversified portfolio that provides areas to book profits and buy into weakness no matter the market environment. (Jim Cramer’s Charitable Trust is long WFC, MS. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
People walk past a Wells Fargo branch on January 10, 2023 in New York City.
Leonardo Munoz | View Press | Corbis News | Getty Images
The countdown is on. Earnings season is set to kick off Friday with the banks, one of ours among them. The whole sector came under heavy pressure last month after the collapse of Silicon Valley Bank. How the banks deliver could set the market tone in the coming weeks.
