The U.S. big banks have released their quarterly results. While earnings were better than expected, they were down considerably compared to last year. Kim Parlee speaks with James Hunter, Banks and Insurance Analyst at TD Asset Management, about the outlook for the financial sector.
KIM PARLEE: Earnings season continues in the United States. The US big banks have reported mixed results. And here to help us decipher what he saw in the insurance bank space is James Hunter. He is a bank and insurance analyst at TD Asset Management. James, it's great to have you on.
Let's just start with the results. US banks have been selling off, but, quite frankly, everything has been selling off in the last little while. What are you seeing right now?
JAMES HUNTER: Yeah, Kim, the equity market's been pretty grumpy, hasn't it? And it hasn't left the US banks. So stocks are down about 15% on the year, giving back the early gains. I guess I'd say the big picture here is that investors are looking past some pretty good results in Q1, and they're looking at all the inflation numbers. This is going to force the central banks to hike interest rates a number of times aggressively. And it's as if we're getting too much of a good thing. Rate hikes are good for banks, but too many are probably not good for the banks and the stocks are responding to that concern.
KIM PARLEE: Let-- maybe you could just expand on that a bit, because it's too much of a good thing-- it's like small children and sugar. As a mom, I know that. But-- so when the rate hikes come-- I know you'd explain a bit about how that means something for default risk and then, of course, the hit to credit. So what do you see happening there? What is the market concerned about?
JAMES HUNTER: Right, it's really the key question you're picking up on there. It's that interplay between the rate hikes and the credit risk. And I guess when you think about the two factors, the ones that really should prevail are the rate hikes. If you go back to the last rate hiking cycle, JPMorgan and Bank of America both increased their net interest income by about $10 billion over a couple of years, whereas their loan loss provisions only went up by a couple of billion dollars, but it's because we avoided a recession.
So a recession would cause provisions to rise and earnings would also fall. And, at the same time, some of the buybacks would come out of earnings. So it really just depends on how the economic cycle plays out from here.
KIM PARLEE: Let's take a look at some of the Q1 numbers that did come out. I know you brought a chart taking a look at operating profits from the US banks. My understanding is the first quarter was better than expected. But when you bring up this chart, it's not quite what we've seen, I guess.
JAMES HUNTER: Yeah, it's neat, isn't it? If-- yeah, if you look at the chart there, you could see how operating profit was down for the big banks in the US. The top three was $24 billion. That was down 8% year-over-year, a bit of a weird contrast to the fact that results were about 10% better than expectations.
What's really going on here is that the US banks over-earned in 2020 and 2021 from their capital markets divisions. So you can think about all the underwriting and advisory fees. Their trading revenues, IPOs, M&As. The market was a bit crazy for a couple of years there and the banks made a lot of money. So they're working through these difficult year-over-year comparisons.
But then if you look into the underlying consumer and commercial banking results, they were pretty healthy. You got 5% loan growth, margins are moving higher, and expenses were reasonably well-controlled, so that gives you a feel for what was going on.
KIM PARLEE: Give me a sense, James, for-- I know you're talking about some of the internals of the bank in terms of how they're generating those profits. I know that you're on calls this quarter for JPMorgan, Bank of America, which generally are pretty good bellwethers for US banks, what stood out for you?
JAMES HUNTER: Yeah, totally. I guess what stood out is you got the initial caveats around the fact that there's so much uncertainty and there's the conflict in Europe, so it makes it difficult for the management teams to make forecasts. But the messages in general were pretty constructive. The CEO of JPMorgan, Jamie Dimon-- he does not think we're going to go into recession and he figures that the economic strength is going to play out for several more quarters.
And then the CEO of Bank of America, Brian Moynihan-- he pointed out really low unemployment, and fantastic wage growth, and also widely available credit. All of these are factors that they expect to continue to push the economy forward. So, in general, I think the tone was pretty upbeat.
KIM PARLEE: What about valuation? I mean, I know that's a tricky question to ask right now, given what's been happening in the market. It's been a bit of a kitchen sink sell-off from what I can see. But I think valuations in the States for US banks are hovering in around 10 times earnings. Correct me again, if that's changed day to day. Are you finding any value out there?
JAMES HUNTER: It's a great question and, regrettably, we're finding value in a few different pockets of the market right now. But, yeah, as you say, it's about 10 times earnings for the US banks. And that's about 10% below the long-term average, which is pretty interesting. And it is also a very wide discount to the broader equity market, so it's something to pay attention to.
The other way you could look at it is book value. The banks are trading at 1.2 times their book value, and that's usually a pretty good entry point. And all of this is to be had at a time when earnings are expected to grow in the low double digits. So I think it's fair to point out that we're seeing pretty good value right now.
KIM PARLEE: What's your outlook would you say for the US banks going forward, given all of that? And, again, I mean, this all has to be layered with some incredible uncertainty which we're seeing in the markets right now.
JAMES HUNTER: Yeah, for sure. I guess what I'd say is that we've held the banks across our portfolios and for good reason. It should be a pretty good time to own the banks in terms of fundamentals because you've got growing loans, you got net interest margins moving higher, you've also got really good credit performance. But if you then think about the stocks, it should be a time where the stocks can be pretty resilient to higher interest rates and that's because valuations in other parts of the market are under scrutiny. Think about technology or consumer discretionary companies.
So I'd say there's an opportunity emerging here in the US banks. You have to be able to stomach the volatility, you have to subscribe to the view that we're not going to have a recession. But if you can sign up for those things, I think you're going to get low double digit earnings growth, get a 3% dividend yield. You only have to pay 10 times earnings, so it feels like you're getting paid to take those risks.
KIM PARLEE: James, I've only got about 30 seconds, but I do want to squeeze in. When you look at outside forces, or new competitive forces, or things happening in the space, anything catch your eye right now?
JAMES HUNTER: JPMorgan puts out a really interesting annual letter in the CEO talks, a lot about some of those risks to the whole space and how mortgage originations are showing up in other parts of the economy rather than the traditional banks. Of course, you've got all the fintechs that are nibbling away at market share. And I think that the main thing is that this is going to cause the big banks in the US to spend more in terms of expenses just to keep up with all the competition that's out there. And it's something that we saw in the first quarter, so we're keeping an eye on it.
KIM PARLEE: Great conversation, James. Thanks so much for your time.
JAMES HUNTER: Thanks a lot, Kim.