- US large-cap banks posted record Q1 2026 earnings, and both earnings growth and asset quality sits well above trend. Yet, investors seem wary about how long the good times can last, for at least four reasons. Bank equities underperformed the S&P 500 and credit spreads widened versus non-financial peers. The market is looking beyond balance sheets and pricing a gap between reported solvency and true loss-absorption capacity.
- First, buybacks offer short-term support but have limits. The Big Six returned over USD110bn in 2025 and ~USD32bn in Q1 2026 alone via share repurchases, mechanically inflating EPS levels. But buybacks support EPS growth only as long as they continue: once excess capital is exhausted, the growth tailwind disappears with a cliff effect, leaving valuations resting entirely on business growth. Elevated trading income and the M&A cycle are both volatile and unlikely to persist at current levels.
- Second, regulatory softening reduces buffers. The March 2026 Basel III/GSIB/stress-test proposals will cut CET1 requirements for the largest banks by ~5–6% cumulatively. Banks have already positioned for this: CET1 ratios for the Big Six fell ~100bps y/y, and this direction will persist as big banks still have rich buffer of around 2pps against the minimum required CET1 ratio.
- Third, SRTs artificially lift reported CET1. Synthetic risk transfers (SRT) have grown five-fold since 2016 (~EUR800bn outstanding), allowing banks to shed risk-weighted assets and boost CET1 ratios without reducing actual exposure. “Organic” solvency, which is not at the mercy of high-risk-buyers, is lower than headline ratios suggest – an estimated gap of 43bps from the CET1 ratio, plus the procyclical and liquidity risk that have not been tested yet.
- Last, long financial cycles analysis points to weaker fundamentals for the banking industry in the years ahead. Based on BIS methodologies, potential financial strains can be detected by examining credit-to-GDP, real credit growth, and residential property prices over 8–30 year periods. This framework, which successfully identified the two last U.S. financial or banking crises (the S&L crisis and the GFC), helps spot out cycle reversals that typically precede stress, though timing remains uncertain. Current signals indicate the U.S. long financial cycle has passed its peak and entered a downturn phase between 2021 and 2023. Emerging strains may extend beyond banks to non-bank financial institutions, given their larger role in the economy. Although real corporate credit growth has been picking up recently, and credit standards have loosened, most other segments (such as mortgages) have been subdued for several years now, suggesting that the US economy is indeed entrenched in the downward phase of the long financial cycle.
- The conclusion is asymmetric. Equity prices may capture the upside created by continuous share buybacks in the short term. But the valuations, which already embed rate-driven net interest income (NII), buyback-fueled EPS growth and M&A super cycle tailwinds, are fragile and leave no room for disappointment. Credit spreads have widened modestly but do not compensate for structurally thinner capital buffers. The largest banks may be well-positioned to weather a downturn; the question is whether their investors are being paid enough for the risk that one arrives.