Takeaways From Bank Earnings - Bezek's Daily Briefing

Includes: C, GS, JPM, LC, ONDK, SPY, WFC, XLF
by: Ian Bezek


Stocks rally on bank earnings, but there's less here than meets the eye.

Big banks aren't big on small business.

What that means for community banks and the regulatory environment.

As we've been discussing this week here at the Briefing, stocks really need to take out 2,100 on the S&P 500 (NYSEARCA:SPY) before we could get a meaningful correction going. Yesterday tested that level, with a sizable morning selloff. But bulls managed to pull the market together, with the indices closing at just minor losses.

Following that, European shares rallied strongly overnight. Throw in some positive bank earnings, and the market is right back to the 2,150 level it has seemed pinned to.

While bears lack the strength to get the market out of this range, I'm not real sold on this rally, at least to the extent that it is being powered by the banks. You see, the banks that actually reported earnings are lagging the rest of the sector.

Wells Fargo (NYSE:WFC), one of the big reporting banks, is actually down on the day. JPMorgan (NYSE:JPM) popped almost 3% in pre-market on its earnings but is now barely green. And Citi (NYSE:C) is up only half a percent. The financial sector ETF (NYSEARCA:XLF) is up more than any of the reporting banks at this hour.

Goldman Sachs (NYSE:GS) is leading the way, up more than 2%, suggesting that people would rather buy the banks that didn't report today. Makes you wonder about the quality of the earnings we're supposedly rallying on.

A Highlight From JPMorgan

One interesting takeaway from JPMorgan's report in particular, courtesy of Twitter user @Vixcontango, is that the bank has very limited interest in US small business:

Out of the $1.7 trillion in credit and capital JPMorgan has raised this year, just $18 billion, or 1%, of that goes to American small businesses.

Those of us who love investing in community banks often receive scorn. Supposedly, these firms are outdated relics on a past time, no longer wanted or needed by society. Most other developed countries don't have many regional banks, and it is often suggested that the US should consolidate its smaller banks in the name of efficiency.

And yet, community banks still originate more than half of all US small business loans today. And to the extent that they have competition, much of it comes from credit unions, rather than the big banks.

Sure, JPMorgan and other big banks make gestures toward small business. JPMorgan, for example, made a big splash with its partnership for online lending via OnDeck Capital (NYSE:ONDK). However, it's unlikely most community banking relationships will go that way in the near future. That is, if regulators don't cripple smaller banks by taking away their discretion. Here's a clip from the ABA Banking Journal earlier this year discussing the issue:

"Discretion is now a dirty word," says David Lacy, noting that even for highly rated banks regulators frown on discretionary pricing. "We know our customers and we have a relationship with them that is very special. We from time to time use our discretion to loan money outside of a box, and that is the fiber, the fabric of community banking." Lacy is president and CEO of the $400 million Community Bank & Trust in Waco, Texas.

And if the replacement for discretion in commercial lending is "algorithmic lending," Zanck adds. "I think it's the communities and it's small businesses that lose out. We realize the consumer side has been commoditized. The question is whether or not that will spread into the small business consumer lending."

"To the extent that regulators in faraway places start creating models and guidelines to take that discretion away from us, they're doing more to hurt us than anything else they could do," Lacy adds. "We cannot not have discretion in our business model."

While the commoditization of consumer lending isn't necessarily a terrible thing, a similar process for business lending would be harmful to the broader economy. Big banks simply don't care, in most cases, about smaller lending opportunities. If it doesn't hit a minimum fee threshold, they aren't even going to look at it.

Sure, if they can figure out some way to automate origination and package small business loans into larger bundles, big banks would certainly get involved in that. But discretion is necessary for many types of business lending - and unlike with consumer lending - many people lose their jobs if small businesses can't deal with flexible counterparties.

I don't think we want a world where the likes of LendingClub (NYSE:LC) and OnDeck are deciding, via computer formula, which small-town companies get the credit needed to live, and which will get shuddered.

Much of the populist anger against the too-big-to-fail banking system is due to the fact that banks are seen as only caring about fat cats. JPMorgan only raising 1% of its overall funds for small business certainly does nothing to dispel that idea.

Goldman Sachs, for its part, is rolling out Marcus.com. This will compete with LendingClub and Prosper, offering high-interest rate loans direct to consumers. These are unlikely to win the bank much approval from customers, though they should be nicely profitable.

The banking sector's recent moves - even putting bad apple Wells Fargo aside for a minute - speak to a group of institutions that feel largely immune from regulatory action. They keep doing whatever will maximize short-term results. However, they seem to spend much less time on actually taking actions that would promote a healthy and well-functioning national credit market for the longer term.

While the big banks may be able to keep up their ways for the time being - Hillary Clinton's Wall Street speeches seem to indicate she's no hard-liner on big banks - eventually a turn will come. The popularity of figures such as Bernie Sanders and Elizabeth Warren suggest there is widespread general discontent with how the banking system functions.

When changes are made - and it's a when, not an if - the winners should be smaller banks, rather than the too-big-to-fail outfits. With that in mind, I suggest not getting too excited on short-term earnings driven banking rallies. The big banks will stay optically cheap, regardless of short-term results.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I'm a lender through the Lending Club platform.