Show Transcript
U.S. banks have seen their Q2 profits plunge due to rock-bottom interest rates and preparations for a surge in loan defaults. Anthony Okolie speaks with Monica Yeung, Global Financials Analyst, TD Asset Management, about the latest results and how U.S. banks are weathering the pandemic.
Print Transcript
[MUSIC PLAYING]
- While many of the US's biggest banks saw their profits fall during the second quarter, some banks actually benefited from a good sales and trading environment. Monica, what's your take on the latest results?
- So large-cap US banks wrapped up Q2 earnings last week. On average, banks actually beat on earnings expectations. And in a typical quarter, I would tell you that's a great thing. That's a good thing. But this is unusual times. These are exceptional times, and so beats and misses, comparisons to consensus really don't matter as much this quarter as they would typically.
Instead, investors are much more focused on outlook and on underlying earnings, and here's where the picture gets a little bit more murky for the US banks. So in terms of underlying earnings, if you looked at banks that reported a profit, the big banks that reported a profit, earnings per share was down more than 50% compared to last year. So despite very strong sales and trading activity, there were a bit larger-than-expected loan-loss results.
On top of that, in terms of outlook and guidance, the environment there is even more murky. I'd say, generally speaking, management teams don't expect the current environment to abate anytime soon. And, in fact, if you looked at the two largest banks, JPMorgan and Bank of America, they expect unemployment rates in their base case to stay well above 7% into the end of 2021 with GDP recovering only in 2022, 2023.
So it was a Q2 earnings beat for the large-cap US banks. But in terms of underlying earnings and outlook, the environment is much more murky there for US banks.
- So what are some of the catalysts that are driving US bank performance in the second quarter?
- So in terms of the second quarter, really capital markets was the name of the game. It was a beat across the board, and, in fact, many banks reported record results. So if you looked at the large US investment banks-- this would be JPMorgan, Bank of America, Citi, Morgan Stanley, Goldman Sachs-- they saw investment-banking fees up more than 50% compared to last year on very strong equity- and debt-underwriting activity as well as decent advisory fees as well.
If you looked at trading results, the numbers there were even more strong. So fixed income, currency, and commodities trading up more than double compared to last year and equities trading up more than 20%, and that's really driven by very strong client activity given the volatile market backdrop. So very strong blowout results in terms of the capital markets division.
- And as we head into the second half of this year, what would you say are some of the headwinds that some of the big US banks face going into the second half?
- I'd really point to two big headwinds for the US banks. The first is loan losses. So you can think of these loan-loss provisions that banks are booking both in Q1 and Q2 as sort of a reserve for a rainy day. So banks are putting up these loan-loss provisions in anticipation of losses that they expect to occur in the coming quarters, in the coming years but haven't quite materialized yet.
So Q1, if you looked at the big six US banks, in aggregate, they put up about $20 billion of loan-loss provisions or loan-loss reserves. In Q2, they topped that by a factor of 1 and 1/2 times. They put up about $30 billion in aggregate of loan-loss reserves. So these are very big numbers and quite a big drag to US bank earnings.
So the other challenge that we see or headwind that we see with the US banks are interest rates. If you think about a bank like JPMorgan, they make about 50% of their revenue through interest-rate-related income, and this quarter we saw our net interest income down about 7% despite very strong or decent loan growth.
And so the reason for that primarily are low rates with the Fed cutting rates to their benchmark lower bound of zero and, with the Fed basically signaling zero rates until at least 2022, will likely continue to be a headwind in the coming quarters and years.
- And what about valuations? Are they cheap right now? Do you think that they can go higher?
- Banks are definitely trading at very low valuation, 0.9 times price-to-book value. Those are levels that we haven't seen since the Great Financial Crisis more than a decade ago.
The reality is is that we do need to see a more constructive economic environment for bank valuations to go higher, and part and parcel with that are loan losses abating but also perhaps more constructive outlook on interest rates as well.
- And what should investors keep in mind going forward?
- Two things come to mind. I think the first thing is if we were to paint an analogy, if this was a typical nine-inning baseball game, we're very early sort of in that story right now, maybe in the third inning. So there's a lot we don't know. So much of the trajectory of US banks really depends on the outlook for the virus, whether or not we get a vaccine, whether or not there's a second wave. And so we're very early kind of in the story of US banks right now, particularly as losses tend to kind of peak and materialize later.
The other thing I would just sort of say is that we've spoken a lot about earnings today, but maybe to end on a more positive note, I would say the balance-sheet story for banks is very strong. The Federal Reserve did release results from their stress tests just a few weeks ago, and with the exception of a couple banks, generally speaking, large-cap US banks have very strong balance sheets. They're very well capitalized. And to that extent, I do expect that they'll be able to weather this storm very well, and their dividends remain safe for investors.
- Monica, thank you very much for joining us.
- Great. Thanks for having me, Anthony.
[MUSIC PLAYING]
- While many of the US's biggest banks saw their profits fall during the second quarter, some banks actually benefited from a good sales and trading environment. Monica, what's your take on the latest results?
- So large-cap US banks wrapped up Q2 earnings last week. On average, banks actually beat on earnings expectations. And in a typical quarter, I would tell you that's a great thing. That's a good thing. But this is unusual times. These are exceptional times, and so beats and misses, comparisons to consensus really don't matter as much this quarter as they would typically.
Instead, investors are much more focused on outlook and on underlying earnings, and here's where the picture gets a little bit more murky for the US banks. So in terms of underlying earnings, if you looked at banks that reported a profit, the big banks that reported a profit, earnings per share was down more than 50% compared to last year. So despite very strong sales and trading activity, there were a bit larger-than-expected loan-loss results.
On top of that, in terms of outlook and guidance, the environment there is even more murky. I'd say, generally speaking, management teams don't expect the current environment to abate anytime soon. And, in fact, if you looked at the two largest banks, JPMorgan and Bank of America, they expect unemployment rates in their base case to stay well above 7% into the end of 2021 with GDP recovering only in 2022, 2023.
So it was a Q2 earnings beat for the large-cap US banks. But in terms of underlying earnings and outlook, the environment is much more murky there for US banks.
- So what are some of the catalysts that are driving US bank performance in the second quarter?
- So in terms of the second quarter, really capital markets was the name of the game. It was a beat across the board, and, in fact, many banks reported record results. So if you looked at the large US investment banks-- this would be JPMorgan, Bank of America, Citi, Morgan Stanley, Goldman Sachs-- they saw investment-banking fees up more than 50% compared to last year on very strong equity- and debt-underwriting activity as well as decent advisory fees as well.
If you looked at trading results, the numbers there were even more strong. So fixed income, currency, and commodities trading up more than double compared to last year and equities trading up more than 20%, and that's really driven by very strong client activity given the volatile market backdrop. So very strong blowout results in terms of the capital markets division.
- And as we head into the second half of this year, what would you say are some of the headwinds that some of the big US banks face going into the second half?
- I'd really point to two big headwinds for the US banks. The first is loan losses. So you can think of these loan-loss provisions that banks are booking both in Q1 and Q2 as sort of a reserve for a rainy day. So banks are putting up these loan-loss provisions in anticipation of losses that they expect to occur in the coming quarters, in the coming years but haven't quite materialized yet.
So Q1, if you looked at the big six US banks, in aggregate, they put up about $20 billion of loan-loss provisions or loan-loss reserves. In Q2, they topped that by a factor of 1 and 1/2 times. They put up about $30 billion in aggregate of loan-loss reserves. So these are very big numbers and quite a big drag to US bank earnings.
So the other challenge that we see or headwind that we see with the US banks are interest rates. If you think about a bank like JPMorgan, they make about 50% of their revenue through interest-rate-related income, and this quarter we saw our net interest income down about 7% despite very strong or decent loan growth.
And so the reason for that primarily are low rates with the Fed cutting rates to their benchmark lower bound of zero and, with the Fed basically signaling zero rates until at least 2022, will likely continue to be a headwind in the coming quarters and years.
- And what about valuations? Are they cheap right now? Do you think that they can go higher?
- Banks are definitely trading at very low valuation, 0.9 times price-to-book value. Those are levels that we haven't seen since the Great Financial Crisis more than a decade ago.
The reality is is that we do need to see a more constructive economic environment for bank valuations to go higher, and part and parcel with that are loan losses abating but also perhaps more constructive outlook on interest rates as well.
- And what should investors keep in mind going forward?
- Two things come to mind. I think the first thing is if we were to paint an analogy, if this was a typical nine-inning baseball game, we're very early sort of in that story right now, maybe in the third inning. So there's a lot we don't know. So much of the trajectory of US banks really depends on the outlook for the virus, whether or not we get a vaccine, whether or not there's a second wave. And so we're very early kind of in the story of US banks right now, particularly as losses tend to kind of peak and materialize later.
The other thing I would just sort of say is that we've spoken a lot about earnings today, but maybe to end on a more positive note, I would say the balance-sheet story for banks is very strong. The Federal Reserve did release results from their stress tests just a few weeks ago, and with the exception of a couple banks, generally speaking, large-cap US banks have very strong balance sheets. They're very well capitalized. And to that extent, I do expect that they'll be able to weather this storm very well, and their dividends remain safe for investors.
- Monica, thank you very much for joining us.
- Great. Thanks for having me, Anthony.
[MUSIC PLAYING]
