JPMorgan and Citi Pass Pain to Hedge Fund Shorts

JPMorgan Chase & Co. Chief Executive Jamie Dimon calls it “over-earning,” but his isn’t the only bank that still hasn’t felt much pain from loan losses or rising deposit costs. The expected hit from higher interest rates to consumers and the economy at large is yet to arrive and that is a huge boon to big bank earnings.

Hedge funds and other investors focused on macro-economic trends have been betting against bank stocks in the expectation that bond-market volatility and a deteriorating economy are going to cause huge losses and threaten financial stability again. The KBW Bank Index has lagged well behind the S&P 500 over the past six months. Friday’s run of earnings show that at best, bearish investors were far too early, and they might even be just wrong. Shares in JPMorgan, Citigroup Inc. and Wells Fargo & Co. all rallied sharply after they reported third-quarter results. Part of that jump is likely down to short bets being unwound.

In spite of a gut-wrenching leap in government bond yields in recent weeks, fears of a renewed bout of deposit flight from or within the banking system also look misplaced — for now at least. JPMorgan’s Chief Finance Officer Jeremy Barnum said the environment seemed much calmer than in March this year, when regional lenders were destabilized and four banks failed.

Funding costs are still rising, but the pace has slowed and competitive pressure has eased since the first half of the year. Even the US government’s hundreds of billions of dollars’ worth of new Treasury issuance hasn’t sucked cash out of the banking system because money market funds have drained more than $1 trillion from deposits at the Federal Reserve to buy these bonds.

Credit is the other dog that hasn’t barked. As forecast, JPMorgan and Wells Fargo did report the highest write-offs for bad loans since the second quarter of 2020 (for Citigroup, it was the worst since a spike in the first quarter of 2021), but this comparison isn’t as bad as it might sound. The onset of the Covid pandemic in 2020 led banks to make huge provisions for potential bad debts, but swift central bank and government support meant that actual losses stayed relatively low. Banks folded those loss reserves back into profits in 2021.

The truth is that losses are just continuing a slow and steady walk back towards longer-term, normalized rates. Write-offs as a percentage of loans for all three big banks have risen since the end of last year, but in the third quarter they remained way below averages for the period between 2011 and 2020 — after the financial crisis and before Covid.

Loss Rates on Bad Loans at US Banks Are Returning to Normal