The second quarter earnings season has offered an early glimpse into what a recovering economy could mean for the financial sector, and more specifically, banks.

That news is of particular interest to Prospector, as we maintain a high allocation to financials, and the sector has been a natural area of strength where we have consistently found attractive investment opportunities over time.

With many of the largest banks reporting last week, here are some key takeaways:

Credit quality remains excellent. Credit quality continued to improve in the second quarter. Banks were able to release some of their loan loss reserves this quarter, which played a role in many companies beating consensus earnings estimates. This is, however, an accounting-driven earnings boost, and in our view, low quality in nature.

Loan growth remains slow, but management teams are optimistic about a rebound. While there were bright spots in areas such as mortgages, auto lending, asset-backed lending and markets-related lending, both businesses and consumers are awash with liquidity. It will take time for consumers and firms to burn through excess cash, but management teams are very positive about the prospects for loan growth in 2022.

The rate environment continues to be a headwind to net interest income. This was largely expected, but as we have mentioned in prior blogs, we see the potential for continued improvement in the interest rate environment.

Consumer credit card spending in June was higher than in 2019. This is a positive sign for the consumer-driven U.S. economy. Going forward, continued strong consumer spending could also play a role in encouraging greater corporate spending and borrowing. Increased credit card spending is also a sign that consumers are starting to spend their excess cash, which is what could push loan demand higher in the future.

Banks are poised to return significant amounts of excess capital. With the Federal Reserve lifting COVID-era dividend and share buyback restrictions, banks are poised to return large amounts of capital to shareholders. Many large banks plan to return more than 100% of net income over the coming year.

Capital markets activity was a bright spot. Statistics from a couple of banks highlight the strength: Goldman Sachs reported that its backlog of investment banking transactions is at a record level, while JPMorgan realized a record in investment banking fees.

While the mortgage environment is still healthy, volumes were lower than this time last year. Lower refinancing activity and housing supply constraints have affected demand. Greater competition has also impacted mortgage banking margins.

Management teams remain open to M&A activity. We view this as encouraging, as we believe achieving economies of scale and digital synergies via M&A could be a path to higher profitability for select banks going forward.