The major US banks reported quarterly earnings that beat expectations, but the prospect of lower interest rates could pose a risk in the second half of the year. Monica Yeung, Global Financials Analyst, TD Asset Management, talks about the latest results and the outlook for the sector.
- All US banks have reported. What's your take, Monica?
- We've had eight US large cap banks report this week, and all of them have beat on earnings expectations. Now, even though they beat, it doesn't mean that everything is perfect. We've had some puts and takes this quarter. So to put that into context, earnings per share grew at about 5% year over year.
- Is that good?
- It's decent, but I'd say the bit of a drag this quarter was that top line growth. Revenue growth was actually a bit muted, up only 1%. So wholesale banking results, which were negative year on year, were a bit of a drag to revenue. That being said, banks had enough other levers they were able to pull to meet earnings expectations.
In particular, they had very good cost control. They had lower-than-expected loan losses. And also, they've been buying back a lot of shares, so that helped to boost the EPS numbers as well. So overall, I'd say very good, solid, decent result from the US large cap banks this week.
- So good results, but what are some of the headwinds for the banks going forward?
- Number one issue top of mind for bank investors right now are interest rates. We expect the Fed to cut rates later this month, possibly also later this year. And if that happens, it'll be negative to net interest income.
- And that's a big shift for the Fed.
- It is. And so something to keep in mind for banks is that they make about half of their revenue through net interest income. You can think of this as the spread earned on interest from loans minus lower cost funding from deposits. And so just this week, we had three banks actually cut their net interest income guidance for 2019-- JP Morgan, Bank of America, and Wells Fargo.
- And should investors be concerned about that?
- Well, I'd say the cut wasn't as large as feared. It was in the realm of 1% to 2% off their net interest income target for 2019. But definitely something to keep our eye on as we go into the rest of '19 and into 2020.
- You talk about net interest income, but what are some of the other themes that you're seeing play out during this quarter?
- One of the things that really stood out for me this quarter as I listened to some of the bank conference calls was the sentiment from bank CEOs. In particular, they remained very constructive and positive on the economic backdrop. They noted that the US economy is growing, that consumers are healthy, and that consumer sentiment remains very positive.
And so I'd say in terms of themes, that really came out in two ways. The first was volume growth. We saw loans grow at about 3% year over year. Now, there are a couple of standouts to that. In particular, PNC, a super regional bank, saw loans grow 5%. JP Morgan and Bank of America saw core loans grow 4%. And so that's a really large, astounding number when you consider that JP Morgan alone has nearly $1 trillion of loans on its balance sheet.
- So let me ask you-- if loans are growing, why is the Fed concerned? Why are they looking to cut rates?
- I think it's important to keep in mind that the Fed is forward-looking, and so we are many years into the economic cycle. One of the things that have helped bank earnings for many years now has been lower-than-expected loan loss provisions, which is something that we saw as a benefit this quarter as well.
But it's not reasonable to think that that will continue indefinitely. I think as we get later in the cycle, we'll start to see that start to peak up a bit. And if you think of the rate cut as perhaps an insurance cut, that would be a bit of a safeguard against that.
- And finally, what should investors be keeping in mind going forward on US banks?
- So we remain constructive on US banks for two reasons. The first is valuation. Banks are trading at a forward price to earnings multiple of 10 times, which is at the low end of their historical range between 10 and 12.
- So that's cheap. That's a cheap valuation.
- It's an attractive valuation given the environment we're in right now. The other thing I'd say investors should keep in mind is that there's a very strong capital return story for US banks. We expect them to return up to 12% of their market cap to investors through either dividends or buybacks. And so there's very few sectors that offer that value proposition right now. If you consider that in tandem with the valuation, we remain constructive, and we think that there's good value in US large cap banks today.
- Monica, thank you very much for your time.
- Great. Thanks for having me.