The title of this quick missive could very easily relate to this week’s release of the latest inflation data. The Consumer Price Index (CPI) eased off the level reported in recent months, which had been a 13-year high, measuring 5.3% versus a year ago.  The 5.4% inflation rate recorded in June and July had been the highest levels since 2008. At the same time, the “core” CPI (which strips out volatile food and energy categories, and is a favorite barometer at the Fed) declined to 4% after measuring 4.5% in June — a level last seen in the early 1990’s. Seemingly unbridled demand that has been further complicated by supply chain disruptions and resultant inventory shortages, fueled by massive government stimulus and presumably vaccine-related comfort in re-openings and social gatherings, has triggered inflationary pressures not seen in decades. While far from tame, this trendline reflecting continued readings that are slowly softening, could accelerate plans the Fed has broadly signaled to gradually curtail its bond-buying efforts. It is still too early to tell if these readings will prove “transitory”, as Fed Chairman Powell is fond of saying, but for the moment it appears to have soothed some inflation concerns. In the coming months, tapering, infrastructure legislation, unemployment levels, tax policy (corporate and personal), interest rates (and the shape of the yield curve), and, sadly, the implications of the ever-present virus and any new variants, will be items that remain front-and-center in these volatile markets.

The title could have also related to last month’s Jobs Report released in early September, which clearly disappointed. Expectations were for the addition of approximately 750,000 to the labor force, continuing the dramatic recovery from the early days of the pandemic that witnessed the loss of roughly 22 million jobs. In recent months, monthly job gains have hovered near the 1 million mark, so while 750,000 would have obviously represented a slowing of that recent torrid pace, it would have still tracked to driving an effective full recovery of Covid-related job losses by sometime in early/mid-2022. For context, it took roughly 6+ years for the labor market to recover from the Great Recession. This potential “full” rebound from Covid’s decimation was on pace to occur in approximately 2 years. However, the August number reflected an anemic 235,000, further injecting volatility and uncertainty into a recovery picture now clouded by the Delta variant’s impact on surging cases and hospitalizations in numerous communities across the country. With supplemental benefits and pandemic-related stimulus largely running its course in early September, a lot of anecdotal commentary will now quickly convert to empirical evidence in assessing those understandably idled by tectonic shifts in their businesses caused by Covid versus those that may have largely relied on these various support programs to remain on the sidelines. After peaking near 15% nationally, and roughly 24% here in Michigan, unemployment rates have recently declined to a little over 5%. A dramatic improvement, but still nearly 2% higher than pre-pandemic levels, as nearly 5 million Americans remain jobless compared to labor statistics recorded in early 2020. However, approximately 10 million job openings currently exist, and while multiple components and considerations help explain this somewhat illogical “gap” in the labor markets, the hope is that those that continue to be displaced will ultimately find a path back toward full (and rewarding) employment.

But, putting inflation and unemployment aside, this writing simply seeks to highlight the coming optical distortion in forecasted bank earnings next year. I’ve written about the positive (economically and emotionally) impact of the PPP program, the low-rate environment that has fueled the veritable mortgage bonanza of recent quarters, and the significant recent releases of initially sizable loan loss provisions that had been recorded in the early days of the pandemic, as uncertainty dominated the landscape and defensive posturing with regard to one’s loan portfolio seemed to be the order of the day. Consequently, earnings releases through much of the past 18+ months have often been materially distorted and somewhat artificially altered by market events. In other words, absent a deep dive on a case-by-case basis, it has been largely meaningless to draw any definitive conclusions, good or bad, on any given bank’s reported “bottom line” of late. Extending that theme, 2022 Earnings Per Share (EPS) estimates have been coming in at those institutions covered by equity research analysts on Wall Street and the “optics” are unsettling:

As depicted in the chart above, other than Huntington, large out-of-state banks operating in Michigan are projected to show sizable declines from their  expected earnings this year. For banks headquartered here in the state, the optics are even more chilling.  Setting aside the ongoing stabilization and turnaround being engineered at Southfield-based Sterling (although its operations are largely conducted on the West Coast), most of the higher-profile Michigan banks are expected to show 20-30% EPS declines in 2022. Underscoring the mortgage-related nirvana most have experienced of late, Flagstar’s year-over-year EPS contraction is expected to measure more than 40% as residential lending production levels and gain-on-sale margins abate in a projected rising rate environment.

This is not an isolated  Midwest nor a Michigan “challenge” facing financial institutions. When we looked at the approximately 300 publicly-traded banks that possess analyst estimates for both 2021 and 2022, we observed that almost 3/4 show a year-over-year decline, as depicted in the chart above. Collectively, the nearly 300 organizations actively tracked by Wall Street show a median EPS drop of approximately 9%, and an average decrease of nearly 8%, in 2022.

However, it is critically important to highlight that while this data, at first blush, may appear disturbing, it is not necessarily Armageddon for the banking sector. Conversely, as mentioned earlier, PPP-related production and fees, coupled with a robust mortgage environment and the opportunity to release credit loss reserves as projected asset quality deterioration did not materialize to the extent first anticipated in the early days of the pandemic, has in many cases somewhat artificially (and unsustainably) inflated 2021 earnings. Consequently, analysts and investors will be even more focused on the underlying fundamentals reflected in 2022 earnings releases — key asset quality metrics, core portfolio growth, long-term funding mechanics, operating efficiencies, underwriting and pricing discipline, margin dynamics, risk management architectures, etc. —   in accurately assessing the performance and relative value of individual banks. Sometimes things are not as they appear, and 2022 EPS figures may prove to be a case-in-point for many. Perceived deterioration may actually underscore strong franchise development and long-term value creation. Don’t be distracted by the headlines, nor pressured by historical expectations that reflected continued bottom-line growth, all things being equal. An observed step back may in reality be a meaningful step forward.

These have been unprecedented times and relative performance has been distorted given business upheavals and market gyrations triggered by Covid. We all anxiously await the point in time when this virus will truly be in the rearview mirror, and the dust settles on all this uncertainty and dislocation caused by the pandemic. Until then, remain focused on your markets and disciplined in your execution. Irrespective of whatever turmoil surfaces in any given business cycle, or the occurrence of a black swan event like we are experiencing over these past 18+ months, continuation of the basic blocking & tackling that has helped you build a successful operation while adapting to technology and market-driven paradigm shifts in the banking industry over the years is always a viable strategic path.

As I commented a few months ago, the resiliency of Michigan’s banking sector has been tested, and validated, many times over the decades through economic downturns, war, natural disasters, civil unrest, political upheaval, and most recently a devastating healthcare crisis. We always seem to come out the other side both stronger and wiser for those able to weather the prevailing storm.

In closing, attached please find our monthly summary of Michigan’s financial institutions. As you and your Board take your organization forward, please do not hesitate to reach out to me and/or my colleagues at ProBank Austin if we can be of any assistance in helping you assess the competitive landscape.  My best wishes as you move through 2021 and prepare for 2022. And again, this simple but heartfelt counsel: Be careful. Be smart. Stay healthy. Take care of your family, your colleagues, your community. Most important, be sure to take care of yourself. God bless.