Increasing bond yields, a recovering economy, and a trillion-dollar stimulus have lifted U.S. bank earnings in Q1. Kim Parlee speaks with Monica Yeung, Global Financials Analyst, TD Asset Management, about the drivers of earnings, and whether U.S. financials may continue to outperform in 2021.
- US banks just reported a blowout quarter, solo stocks trading more than twice their value since the pandemic lows and up to 20% in the last year, and that's far outpacing the gains that we've seen in the S&P 500. So the question is, have some of these bank stocks gone up too far too fast, or could there be a bit more ahead?
Here to give us her thoughts from the fundamental standpoint is Monica Yeung. She's Global Financials Analyst with TD Asset Management. Monica, great to have you with us today. As I mentioned, the earnings that came out from the US banks-- very strong right across the board. Maybe you can just tell us some of the key drivers across all the banks that we were seeing.
- First of all, Kim, thanks for having me. It's great to be here. What a week it was for US banks. Six of six big banks reporting massive beats to expectations, earnings about 50% higher than Street estimates for the quarter, big headline beat.
And I would really point to two key drivers of that beat, the first being record capital and markets revenue. So businesses like trading, investment banking, equity underwriting really had excellent and, in some cases, blowout results. The other thing that we saw was big beats on credit. So in aggregate, the big banks actually released $13 billion of credit reserves off their balance sheets into income, a reflection of an improved economic outlook, and that really helped to boost the earnings number this quarter as well.
What's interesting, Kim, is if you looked at share price reactions for the big banks this quarter on announcement date, most banks were actually flat to slightly down, and the reason for that is that the market tends to look through credit and trading-driven beats. If you look at some of the underlying drivers of earnings, things like loan growth, net interest income, earning expenses, those are actually a bit weaker than we had expected, so net-net, big headline beat offset by some weaker fundamentals. That's really the story for the big US banks in Q1.
- It's interesting, because you mentioned some things that markets tend to look through. I guess the temporary nature of some of that trading revenue and the temporary nature of some of those losses being converted into income. Tell me, are there anything on a more permanent basis you're seeing from a fundamental standpoint, some trends that you're seeing that either positive or negative?
- Yeah. I would say that, historically, market has looked through some of the capital markets revenues, but there are still tailwinds to carry that through over the next three or four quarters, at least until the end of the year. It's interesting, because if you look back to Q1, Q2 of 2020, trading results off the back of a very volatile market environment saw big blowout trading results. That followed with very strong debt underwriting revenues as corporates tapped the bond markets to really buffer their balance sheets.
More recently, it's been equity underwriting with the SPAC boom and IPO market. And I think the next leg to follow in terms of capital markets results is really going to be advisory. So we know that corporates are looking to do M&A, that private equity is flush with cash, stocks have the capital to pursue $300 billion worth of acquisitions. And so all of that spells for very strong M&A pipelines, very positive for investment banking advisory revenue. So I would look for that to really carry through over the next few quarters.
- Interesting. I was going to say, we'll probably see some of that coming up even in the bank sector in the next little while in terms of some of that M&A piece with restrictions being lifted up. I want to touch on-- and apologies for interrupting, but I wanted to touch on just interest rates. What do you see happening there? I know the hope for many banks is you might start to see rates go up, of course, but then the pandemic happened. So what are you seeing?
- Yeah, interest rates hugely impactful for bank earnings. Reality is that about 50% of revenue is derived from interest rate-related items, so net interest income as we call it. That is definitely down year over year as we've seen rates collapse across the yield curve. But the outlook, I'd say, is a little bit more positive now than it was, perhaps, six months ago.
A bank like Bank of America, for example, has said that if what's implied in the yield curve today plays out, then they could see their net interest income, which I said is 50% of their revenue-- they could see that up about 10% by Q4. So in a few quarters, actually, we could definitely start to see some lift in that. All of that falls down to the bottom line in terms of earnings, so we could see double-digit lift in earnings if we even just see current rate expectations kind of play out over the next few months.
- What about the actual valuations themselves? Obviously, all that net interest income falling to the bottom line helps, I'm sure. People very eager to see that happen if you're invested in banks. But what about just-- we've seen some real violent rotations from growth stocks to value. So what do you see? How is that impacting the financials?
- Yeah, so US banks up about 20% year to date. They're up actually 50% if you measure it from the period of vaccine announcement on November 9 to to date. And over that time period, valuations have really rerated from about 10 times price to earnings to 12 times PE as it stands right now.
I'd say the next leg of the move for US bank stocks is really going to be reliant on earnings, so what I kind of pointed to earlier, loan growth-- we have to kind of see that revive itself, net interest income improving, expenses being much more controlled than we've seen in the last little while. And then, importantly, also, buybacks are a big part of the story for the US banks as well.
I do want to touch on one thing, which is loan growth. I mentioned earlier that it was a bit weaker than expected this quarter. This is one thing that we really need to start moving for the US banks to get these bank stocks up on its next leg of performance.
This quarter, for example loan growth was actually down 5% year on year. And you think of some of the reasons behind that-- consumers are stuck at home. They're flush with cash, also really not spending or tapping on credit the same way that they used to be.
And then on the other side of the coin, businesses are kind of reluctant to tap on their credit lines, reluctant to take out new loans in the face of uncertainty. But with the economy re-opening, really not reasonable to think that kind of environment will stay around forever. And my expectation is that loans will recover, certainly in 2022, likely even in the back half of this year.
So you have a setup where you have loans accelerating, interest rates improving the whole picture for banks, and that's really positive in terms of earnings growth looking in over the next 12 months.
- Optimistic outlook. Monica. We'll have to leave it there, but such a pleasure. Thanks so much.
- Great, thanks for having me.