US Banking on Solid Ground: Q1 2025 Earnings Show Resilience Amidst Uncertainty

Banking on Solid Ground: Q1 2025 Earnings Show Resilience Amidst Uncertainty

Hello Fellow Investors,

The first quarter of 2025 is in the books, and for large-cap banks, the narrative is one of surprising strength and cautious optimism. Despite a backdrop of policy and macroeconomic uncertainty, including tariff moves that many anticipated would shake the financial sector, these institutions aren't blinking yet. Our latest industry update reveals that all covered banks beat lowered earnings per share (EPS) consensus estimates. What's particularly noteworthy is that most banks reaffirmed their early 2025 guidance, suggesting a degree of confidence that has resonated throughout earnings calls.

Key Takeaways from Q1 2025:

• Earnings Beat: The average beat for core EPS among large banks was a solid 7%. This positive surprise was driven by a combination of fees not being as weak as feared (particularly in equities trading for money center banks), net interest income (NII) slightly exceeding expectations, and continued strength in credit with reserve builds being less substantial than some anticipated. The group saw a +12% year-over-year (YoY) increase in EPS in Q1 2025.

• Revenue Growth: Banks demonstrated an ability to control costs even with inflation, as revenues outpaced expenses (5% vs. 3% YoY). Big bank revenues grew 3% quarter-over-quarter (QoQ) and 5% YoY, fueled by ongoing NII growth and better-than-feared fee income, particularly in capital markets. Investment banks saw the highest YoY growth in revenues.

• Resilient Balance Sheets: Banks are starting from a position of strength, boasting strong balance sheets, excess capital, and good credit quality. Non-performing assets (NPAs) and loan losses remained flat QoQ, and card delinquency pressure eased YoY. Loan-to-deposit ratios of 70% are below the long-term average, indicating de-risked loan portfolios. Even with pandemic-like reserve builds, the report estimates banks could absorb the charges within a few quarters and still grow book value.

• Regulation on the Horizon: A potentially significant shift in regulation is anticipated in the second half of 2025. The Treasury Secretary has emphasized a regulatory overhaul to encourage lending, and the prospect of new policies could bring benefits in terms of regulations, efficiency, and a "revolution of common sense". Furthermore, there's a possibility of more excess capital with the neutralization of Basel III (B3) and revisions to the Federal Reserve stress tests.

• Capital Returns: In Q1 2025, buybacks increased by half QoQ and doubled YoY, signaling management's confidence and the availability of capital. Forecasts suggest that buybacks will continue and even accelerate in the coming quarters.

Looking Ahead: Inflection Points and Potential Roadblocks

The report highlights several key inflection points expected for the banking sector. EPS is projected to inflect YoY from negative and flat growth in previous years to double-digit growth for the next three years. This positive trajectory is expected to be aided by a likely new era of banking driven by more favorable regulation in the latter half of 2025 and beyond.

The NII inflection appears to be on track, even considering potential trade war impacts, with the true inflection expected after the first quarter of 2025. While fees and credit could face some headwinds, EPS growth is still anticipated in most scenarios.

Capital markets are also in a multi-year inflection, expected to grow by an estimated 30% from 2023 to 2027. While investment banking (IB) may remain somewhat weak in the near term, strong trading revenues are expected to more than compensate.

However, the report also underscores several risks that could impact the outlook:

• Unemployment: Current reserves are largely based on a 5%-6% peak unemployment scenario. A different trajectory could necessitate additional reserve builds.

• Interest Rates: The delayed effects of high interest rates could negatively affect credit (especially commercial real estate) and NII (due to deposit costs and mix).

• Economic Activity: Major policy decisions could create distinct winners and losers among bank clients. Small businesses, with potentially greater reliance on specific supply chains or countries, may be more vulnerable.

• Tariff Uncertainty: The ongoing uncertainty surrounding tariffs and policy adjustments remains a significant risk, potentially dampening corporate sentiment and impacting M&A, underwriting, and trading activities.

Investment Strategy: Mind the Gap

The analysts remain positive on banks for 2025, but advise investors to "mind the gap" related to potential tariff issues. If clarity emerges on global trade by the second-quarter earnings, the themes that propelled banks earlier in the year could resume in the latter half. Despite recent volatility, the underlying fundamentals and the potential for positive regulatory changes suggest a favorable outlook for the sector. Citigroup (C) remains a top pick, with expectations of significant stock appreciation driven by earnings growth and improved efficiency and returns.

In conclusion, the first quarter of 2025 painted a picture of resilience and better-than-expected performance for large-cap banks. While uncertainties remain, particularly concerning global trade policies, the underlying strength in balance sheets, the anticipation of positive regulatory changes, and the expected inflection in key financial metrics offer a compelling investment narrative. As always, staying informed and monitoring the evolving macroeconomic and policy landscape will be crucial for navigating the opportunities and challenges ahead.

Companies mentioned in this report with an Overweight rating include: Bank of America (BAC), Citigroup (C), Fifth Third Bancorp (FITB), J.P. Morgan Chase & Co. (JPM), KeyCorp (KEY), and PNC Financial Services Group (PNC).

Stay tuned for further updates and analysis.

Sincerely,

David, The Valuation Street