What to watch as bank earnings kick off

The Street

Here's what bank earnings might reveal about the economy and market trends.

Transcript

00:00Joining us now is Ken Leon. He is Global Research Director at CFRA.

00:05Ken, thanks so much for joining us. Great to have you.

00:07Great to be here.

00:08So, Ken, bank earnings season kicks off next week.

00:11We've seen this really impressive performance from the Big Bang since the April lows.

00:16What's next? What are you expecting to hear from some of these banking giants?

00:20Well, that's true. And what a change from when they last reported in April

00:25when there was tremendous uncertainty in the markets, in the world.

00:29And what that could be, which was mostly banks telling us of a cloudy outlook.

00:36Today, quite different in terms of where we are.

00:40We're expecting the banks to have more confidence,

00:44not only in reporting what we think will be strong second quarter results,

00:49but also the outlook for the second half of this year into next year.

00:53There's a lot of factors that go into that confidence that we have as well,

00:58which is especially an improvement in the capital markets.

01:03Also, the U.S. economy is not falling off the table.

01:07We're seeing economic growth, which is good both for loan growth

01:12and also less concern about moving out of the normal range

01:17in terms of credit risk or delinquencies.

01:19Not as cloudy of an outlook, but still some uncertainty out there

01:25and stock prices that have run much higher.

01:27So how high is the bar and which banks do you think will clear that bar?

01:32Well, that's right.

01:33So at CFRA, we have an overweight on the financial sector.

01:37The banks are, you know, six of the top 10 constituents are the large global banks.

01:44What we've seen and where I sit here looking at all the markets around the world

01:49is increasing confidence about the capital markets.

01:54And here it started in Hong Kong with IPOs.

01:57We've seen some high profile IPOs here in the U.S.

02:01Additionally, we're beginning to see the pipeline come to market

02:07and mergers and acquisitions, which has been really very quiet

02:12over the last 18 to 24 months.

02:16There's the beginning of M&A activity.

02:20Not only corporates, but about 20, 25% of those transactions

02:24are driven by private equity firms,

02:27which have $2 trillion of owned companies that need an exit ramp

02:33so they can finish old funds and do fundraise on new funds.

02:37That will be a big part of the story for M&A and investment banking

02:41over the next two years.

02:43To your question, which banks?

02:46We think the Delta is those who are more exposed to the capital markets,

02:52Goldman Sachs, Morgan Stanley, even Citigroup.

02:55Less so maybe for the regional banks or Wells Fargo.

03:01We did downgrade it maybe a couple weeks too early,

03:05Bank of America from buy to hold.

03:07Also, JPMorgan Chase probably should have waited.

03:10But those banks have two factors.

03:12One, more exposed to the general economy, to loans,

03:17and then also interest rates on net interest income.

03:21Just to be an analyst for a moment,

03:23those banks, the latter, 55%, 60% of their total revenue

03:28is net interest income.

03:30Morgan Stanley and Goldman Sachs, well under 20%.

03:33So again, I'm coming back to the capital markets.

03:36That's part of the bull case scenario for the second half this year

03:40and confidence for next year.

03:42One other area or two that we should talk about

03:45is the Trump administration and public policy

03:48policy to open up regulation than, of course, the Fed.

03:52You're obviously turning more cautious then with the downgrade a few weeks ago

03:58on JPMorgan and Bank of America.

04:00As you said, you made the point it could be due to net interest income.

04:04But is that also maybe a red flag about the strength of the consumer

04:09as you think about the back half of this year?

04:12Not really.

04:13I mean, these are still halts.

04:15We're not negative.

04:17It's more so, you know, these stocks are up over 30%, 35%.

04:22The valuations are a little bit stretched.

04:25That being, you know, on looking at price to book value,

04:29you know, sometimes crossing two times.

04:32You know, so overall, what I'm saying as an analyst is

04:35how do we support current or future valuation?

04:38It's going to be earning those earnings, which, again,

04:41I think there's more of an impact or contribution from the capital markets.

04:45Also, those banks, Goldman or Morgan Stanley,

04:49have superb leading franchises in asset management and wealth management,

04:54which give you durable recurring revenue.

04:57And, of course, mark-to-market with elevated market prices

05:00here in the U.S. and around the world.

05:03That's going to be great fee income for them and for the other banks.

05:06Ken, do you think we'll get clarity in terms of outlook from the banks this time around?

05:10I think we're going to get more confidence.

05:13And the likelihood is, you know, guidance for this group is very paltry.

05:19There isn't much.

05:20There might be a guidance for total expenses for the year or net interest income.

05:26But I think overall what they're going to be saying is

05:28there's a lot of activity with clients.

05:31What they're seeing is the CEOs, CFOs, being much more active of what they want to do

05:38on going to the public markets for their investments.

05:43Additionally, and Bank of America, Brian Moynihan, the CEO,

05:47is really great about talking about the consumer.

05:50I don't think there's any red lights there.

05:53I think mostly he's still going to be talking positive about the U.S. consumer,

05:59which is important for credit card and personal loans.

06:03You know, so overall, you know, again, there's just surprising normalcy,

06:08even though there's been tremendous stir of the trade tariffs and uncertainty, for sure.

06:14I'm curious, just finally, do you think we'll hear a much different picture

06:18from the smaller regional banks than we'll hear from the bigger banks?

06:23So we look at all the banks, and my colleague, Alexander Yokeman, who covers it,

06:29is looking for the super regionals to be having outstanding results.

06:34And again, the concern would be two factors.

06:39You know, again, that metric called net interest income, you get there in two ways.

06:43Direction of rates, which right now, lower rates is not the best thing.

06:48But if the economy is strong, then you make it up on volume,

06:52loan volume, to get the higher net interest income and margins.

06:56I think those banks are going to be talking about that

06:58and also not taking any significant reserves,

07:02either for concerns about the consumer or, again, across all the banks,

07:08any black swan event that would hurt the banks

07:12and hurt, obviously, their share prices.

07:14Ken Leon, CFRA, appreciate you getting us ready for bank earnings.

07:19Thanks so much.

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