Earnings season is off and running. We saw the first big bank earnings on Friday, and while they were not awful, the stock market did not think that much of them. JP Morgan (JPM). Wells Fargo (WFC) and JP Morgan were all three down despite a pretty strong rally in the braider markets.

JPMorgan (JPM) reported a strong quarterly net income of $6.12 per share, or $13.1 billion. The return on equity (ROE) was a healthy 23%, and the return on tangible common equity (ROTCE) was 28%. Despite the strong reports, CEO Jamie Dimon highlighted caution due to geopolitical risks, inflationary pressures, and the impact of quantitative tightening.

Credit continues to be a concern and focus for the bank as credit card charge-offs climbed again this quarter. The doom-and-gloom crown will crow about the $credit card charge-offs, but it is worth noting that the total dividend payments and buybacks alone were four times the charge-off credit card accounts in the quarter.

Dimon emphasized the firm's strong capital position, with a CET1 ratio of 15.3%, and announced plans for increased dividends, reflecting JPMorgan's strong financial health and commitment to driving economic growth by extending significant credit and capital YTD.

Unfortunately, Dimon was not on the call, so there was no opportunity for one of his outstanding off-the-rails commentaries this quarter.

Wells Fargo's second-quarter profit decreased, missing analysts' estimates for interest income due to higher deposit costs amid intense competition. This caused shares to drop over 6%. Net interest income fell 9% to $11.92 billion, below the expected $12.12 billion. The bank forecasts a 7-9% decline in NII for the year.

Despite these challenges, investment banking fees surged 38% to $430 million, helping Wells Fargo beat profit expectations. Earnings per share were $1.33 compared to the expected $1.29.

The market did not care, as WFC was the biggest decliner in the S&P 500 Friday.

Office loans continue to be a problem for Wells as it had charge-offs of of$271 million in commercial real estate (CRE), predominantly driven by the office segment. The banks also increased provisions to cover potential defaults, particularly in the office space, reflecting efforts to manage CRE exposure amidst sector troubles.

Wells Fargo continues to manage its CRE portfolio, focusing on reducing exposure and preparing for potential defaults while maintaining a manageable portfolio.

Citigroup Bear estimates that it will buy back $1 billion of stock in the third quarter. Citigroup reported a net income of $3.2 billion for the second quarter of 2024, an increase from $2.9 billion in the same period last year. Earnings per share (EPS) were $1.52, up from $1.33.

Credit card losses were over $2 billion in the quarter, which will send the intern crazy. Very little comment will be made of the fact that it is a $160 billion portfolio or the fact that the bank has over $ 2 trillion in assets.

The big three reports were in line with what I expected to see. We have always known that credit cards would show some signs of the slowing economy this quarter, but I am also aware that most banks have only issued cards to people who did not need them, so overall losses should remain insignificant in the grand scheme of things.

Jerome Powell gave his testimony on Capital Hill this week, and it was the usual clown show that demonstrates the lack of financial knowledge on the part of our elected representatives. The Q&A sessions are more political theatre and a tragic comedy than anything else.

Powell reiterated that inflation has eased significantly but remains above the 2% target. He stressed the importance of well-anchored long-term inflation expectations, noting that "a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets, suggest stability in these expectations.

The Fed Chair once again warned that "Reducing policy restraint too soon or too much could stall or even reverse the progress we have seen on inflation." Powell emphasized that the Committee does not expect it will be appropriate to reduce the target range for the federal funds rate until there is greater confidence that inflation is moving sustainably toward the 2% target.

Discussing the proposed new capital regulations for big banks, Powell ruined Michael Barr and Elizabeth Warren’s Day when he told Congress that significant progress had been made and that a revised proposal was likely to be released for public comment soon. He remarked, "It is my view, as is the strongly held view of the members of the board, that we do need to put a revised proposal out for comment for some period."

That delays implementation and makes it far more likely that any increase in capital levels would be lower than that proposed by the anti-banking segment of the regulators.

A big part of the market rally late in the week came after a very weak CPI report, which gave traders hope that there was finally enough data to support a rate cut.

The U.S. Bureau of Labor Statistics reported a slight decline in the Consumer Price Index for All Urban Consumers (CPI-U) in June 2024, marking a notable shift in inflationary trends. The CPI-U decreased by 0.1 percent on a seasonally adjusted basis, following a flat reading in May. Over the past 12 months, the all-items index rose by 3.0 percent, showing a deceleration from the previous month's 3.3 percent increase. This slowdown in inflation was primarily driven by a significant drop in gasoline prices, which fell 3.8 percent in June, continuing its downward trend from May.

The big reason for the weakness was the same force that has been the dominant behind the inflation reports all year. As energy resonates, so do the inflation numbers.

People shopping at the grocery store or writing checks for food, electric bills, or insurance will not notice any difference anytime soon, but the numbers do give traders some hope. While energy prices declined, other sectors of the economy showed mixed results. The food index increased by 0.2 percent in June, with food away from home rising 0.4 percent and food at home up 0.1 percent. The index for all items less food and energy, often considered a measure of core inflation, rose by a modest 0.1 percent in June, the smallest increase since August 2021. Shelter costs, which have been a significant driver of inflation, showed signs of cooling with a 0.2 percent increase, the smallest rise since August 2021.

Most traders skipped the line in the report that said the data suggests that while inflation is moderating, it remains above the Federal Reserve's 2 percent target, potentially influencing future monetary policy decisions.

Please read that line and then the line above about cuts not being appropriate until inflation is moving sustainably towards the 2% target.

Powell and the rest of the committee discussed at the last meeting the fact that the biggest risks to the inflation outlook were to the upside.

If any significant events impact energy prices of major supply chains, all talk of a rate cut will be over.

The outlook for bank M&A remains unchanged.

We need more bank M&A activity.

Smaller banks are struggling to deal with regulatory changes, succession issues and, increasingly, the cost of technology. The trend toward digital has accelerated at warp speed since COVID-19, and that is unlike to change.

To complicate matters, every dime spent on technology requires an additional nickel to be spent on cybersecurity.

The administration is starting to figure this out, and if they stay in office, the slower pace of M&A should accelerate.

If the other guys get in the deal, the pace picks up immediately.

Activists are noting the current undervaluations in the banking sector. In the first half of 2024, investor activism targeting US banks reached its highest level in the last five years, with 45 campaigns already launched. This surpasses previous years, including 2023, which had 39 campaigns.

Increasingly there is another buyer that is making waves in bank M&A. In 2024, several additional credit union acquisitions of banks have been notable, continuing a trend that has gained

Hudson Valley CU agreed to purchase Kingston, NY-based Catskill Hudson Bancorp Inc. for $28.6 million. This deal was notable for being the first acquisition of a New York-based bank by a credit union.

Formerly known as Alaska USA Federal Credit Union, Global FCU announced the acquisition of Renton, WA-based First Financial Northwest Bank for $231.2 million. This acquisition is significant due to the large asset size of First Financial Northwest Bank, making it the largest credit union-bank deal ever.

We benefited from that one. Based in Lakewood, Washington, Harborstone Credit Union is acquiring Savi Financial in an all-cash deal. This acquisition, along with the pending acquisition of Seattle-based First Sound Bank, aims to expand Harborstone's reach in the Northwest and diversify its business lines.

Gesa Credit Union announced its agreement to acquire another Washington-based bank. This deal is part of a series of acquisitions that have placed 2024 on track to break previous records for credit union-bank mergers.

Credit Unions have a huge advantage over banks when it comes to M&A. s not-for-profit institutions, credit unions are exempt from federal income tax. This tax-exempt status stems from their original purpose of serving the financial needs of their members rather than generating profits for shareholders.

In contrast, banks are for-profit entities subject to federal and state corporate income taxes, which can significantly reduce their net income.

The tax advantages allow credit unions to offer higher bids for banks compared to other banks, as they have more after-tax income available to finance acquisitions. This can make credit unions more attractive buyers for struggling or small banks looking for favorable deals. Credit unions can use acquisitions to expand their member base and geographic reach without the burden of paying taxes on the acquired entity’s earnings.

It is tax arbitrage at its finest.

Along with banks, we will be watching CRE Mortgage REITs closely in the e quarter.

Ladder Capital Corp. (LADR) stands out as the more attractively positioned commercial real estate mortgage REITs in the current market environment. LADR is noted for its favorable liquidity. In the challenging CRE market of 2024, strong liquidity is crucial as it provides flexibility and a buffer against market stress. LADR has $1,220 million in unrestricted cash and $324 million in approved and undrawn capacity, totaling $1,544 million in estimated liquidity. This represents a significant 29.2% of LADR's assets, one of the highest in the industry.

Ladder has higher loan quality, a well-covered dividend, and a strong balance sheet. It's my top pick in the space.

KKR Real Estate Finance Trust Inc. (KREF) stands out with one of the strongest credit positions among its peers. The company's existing reserves plus realized losses stand at an impressive 4.8%, significantly higher than the 3.0-3.5% range seen in close competitors. This robust reserve position, combined with solid dividend coverage, positions KREF well to weather potential market turbulence. The company has a high exposure to office, so there is headline risk. I would be a buyer on any weakness.

Apollo Commercial Real Estate Finance, Inc. (ARI) also has sufficient reserves and adequate dividend coverage. These factors provide a buffer against potential loan losses and support the company's ability to maintain distributions to shareholders. The company's office loan exposure sits at 20%, slightly below the sector average, potentially insulating it somewhat from the worst of the office market's woes. Again, weakness is a buying opportunity.

Ares Commercial Real Estate Corporation (ACRE) takes a proactive stance on recognizing potential issues, with one of the highest shares of losses already reflected in its book value among peers. This forward-looking approach, coupled with sufficient dividend coverage, positions ACRE as a potentially resilient player in the market. Ares has high office exposure at 37.8%, which could present headline and default risk; as with the others, I would be a buyer on weakness.