Not all banks are created equal

Earnings season is back underway as JP Morgan and Goldman smash estimates. However, as Wells Fargo disappoints, investors need to understand that not all banks are created equal.

Look at the stock market over the last few months and you get the impression every man and his dog has been long growth and technology stocks. For banks however, it has been a different story. As the Nasdaq hits new highs and the S&P closes in on turning positive in 2020, the bank index (KBW) is down 35% in 2020.

The reason banks have lagged the broader market is in part due to Covid meaning lower rates for longer - low interest rates make it very difficult for banks to make money from traditional borrowing and lending, and this is unlikely to change soon with the 10-year treasury hovering at 0.7%. However, investors also have to grapple with the risks of banks' loan books going bad, and the visibility that investors have on the extent of these losses remains incredibly murky.

It is clear that banks will incur significant loan losses, but investors can remain calm in that the Covid-crisis is not 2008 - this crisis is not a financial one, depsite its financial ramifications, and the banks, especially the larger ones, are in good health and are well capitalised.

This week is key as we get the first report from the banks on a quarter filled with rising unemployment and navigation of the Paycheck Protection Program. JP Morgan and Goldman have impressed in particular as volatility provided trading desks with record revenues - and with volatility likely to continue, investors should be wary of banks who aren't able to offset their loan losses with their capital market operations. Just like investors need diversified portfolios, banks need diversified business models.

This isn't to say you should avoid regional banks such as PNC and East West Bancorp, but your risk is much more concentrated on loan and credit losses. Bigger doesn't mean safer for banks though as Wells Fargo showed on Tuesday when they reported their first loss since 2008 - unlike JP Morgan, Goldman and Citigroup, they are unable to soften the pain of their loan losses through trading volumes.

As Covid-19 cases continue to be prevalent in the US and states such as California re-enter lockdown, these losses may continue whilst stock market volatility persists. This further adds fuel to the case of owning those banks with significant trading exposure.

Banks can often be seen as boring investments but at the moment they provide very exciting opportunities for investors. But don't forget, if you want to profit from increased trading volumes without the fear of loan losses, there are always the exchanges such as ICE and Nasdaq - you'll just have to pay a lot more for them...