Show Transcript
U.S. banks reported improved third-quarter results from the previous quarter, but continue to lag the broader S&P 500 Index. Are there any signs that’s going to change? James Hunter, Co-Portfolio Manager, TD Asset Management, talks about the latest results and the outlook for the sector.
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- US banks have just reported their third quarter earnings, which have improved over the previous quarter. But as the chart shows, they still continue to underperform the broader market. So are there any signs that things are going to change?
Well, joining me is James Hunter, Co-Portfolio Manager and Vice President of TD Asset Management. James, before we get into the latest quarterly earnings, why have US banks done so poorly against the broader market?
- Yeah, it's been a tough year for the banks, Anthony. The stocks are down 35% so far. And that's in the green line in the chart that I brought, and it is way behind the broader market.
And I guess I'd frame up the discussion in terms of the macro backdrop and the fundamentals. The global health pandemic threw us into a really deep recession this year. And that's just a bad environment for bank stocks. If you think about it, unemployment rises, businesses really struggle, and interest rates fall, which reduces the net interest income that banks earn on their loans.
And then another factor is we are heading into an election in a couple of weeks in the US. And there's a good chance that the outcome will usher in policies such as higher taxes or regulation on corporations. That would also be bad for the banks. And it's been affecting sentiment.
And then lastly is just fundamentals, as you mentioned. Earnings are down 50% this year compared to last year. And that's on the back of slower loan growth, lower margins, and higher provisions for credit losses. So all of these factors together have really made it impossible for the banks to keep up with the big technology companies moving the market higher.
- OK, so given that backdrop, what's your take on the latest results?
- Overall, I'd say Q3 was a tough one. If we take a look at that second chart that I brought, it shows the cumulative net income for the big four banks. And in Q3, it was $18.8 billion. Now, that's a really nice increase from Q1 to Q2 on the back of lower provisions. But it is still down 20% year over year.
And if you think about a traditional consumer banking, it's struggling against these lower margins, which were down about 15 basis points sequentially. Now, that may not sound like a lot. But it is a really meaningful number. And then wealth and capital markets-- that just couldn't make up the difference. So despite the fact that the results were a little bit better than expectations, the underlying trends just weren't good enough.
- So were there any bright spots for you in the third quarter, as well as the outlook for the next year?
- Yeah, so that's a good question. And I guess the one thing that we haven't touched on yet is capital. If you look at the common equity Tier 1 ratio of the big banks at the end of the quarter, it was 12%. And JP Morgan actually put up 13%. These are really huge numbers.
And it just speaks to the fact that there's about $100 billion of excess capital versus regulatory minimums. And what this should do is give investors confidence that the banks will be able to weather any headwinds that come at them in the future from a capital perspective.
In terms of the outlook, we have had expectations that credit card spending is going to pick up in the next couple of quarters, and also that net interest income probably bottomed in Q3. And that would give the banks a good setup for next year, because NII is typically 50% to 60% of bank revenue. So those are some of the bright spots amongst the murky outlook.
- OK, so the big question as well now is what about valuations? Are they cheap right now, and could you see some improvement over the next coming months?
- Yeah, so it depends a little bit on which metric you look at. The banks are currently about 20% below their book value. And historically, that is an attractive level. But I would argue for a bit more of a focus on earnings and dividends.
On that basis, we're at about 11 and 1/2 times forward earnings, about a 3 and 1/4% dividend yield. That is somewhat attractive, but it's not a screaming buy. And I think to get valuations moving higher, you need to see that improvement in results, and consistency in the results. And frankly, it would also help if the US Federal Reserve were to allow dividend hikes, because then we could get that really exciting combination of dividend yield plus dividend growth.
- So putting it all together, what should investors keep in mind looking ahead?
- Well, I think that investors should remember that at some point, we're going to have a health care solution to this health care crisis. And unlike the global financial crisis, we can be pretty confident that the banks are going to get to the other side of this. So there's no need to panic.
But when I think about getting the stocks going in a meaningful way and improving sentiment, I think it just comes down to better results. And that would mean faster loan growth, higher margins, lower expenses. And I do worry that to outperform the broader market, we need to see all three.
And it's just a bit tricky to see how that will come together in an environment where interest rates are lower and you've got the potential for higher taxes and regulation. So for now, we remain somewhat cautious on the US banks.
- James, thank you very much for your time.
- Thanks a lot, Anthony.
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Well, joining me is James Hunter, Co-Portfolio Manager and Vice President of TD Asset Management. James, before we get into the latest quarterly earnings, why have US banks done so poorly against the broader market?
- Yeah, it's been a tough year for the banks, Anthony. The stocks are down 35% so far. And that's in the green line in the chart that I brought, and it is way behind the broader market.
And I guess I'd frame up the discussion in terms of the macro backdrop and the fundamentals. The global health pandemic threw us into a really deep recession this year. And that's just a bad environment for bank stocks. If you think about it, unemployment rises, businesses really struggle, and interest rates fall, which reduces the net interest income that banks earn on their loans.
And then another factor is we are heading into an election in a couple of weeks in the US. And there's a good chance that the outcome will usher in policies such as higher taxes or regulation on corporations. That would also be bad for the banks. And it's been affecting sentiment.
And then lastly is just fundamentals, as you mentioned. Earnings are down 50% this year compared to last year. And that's on the back of slower loan growth, lower margins, and higher provisions for credit losses. So all of these factors together have really made it impossible for the banks to keep up with the big technology companies moving the market higher.
- OK, so given that backdrop, what's your take on the latest results?
- Overall, I'd say Q3 was a tough one. If we take a look at that second chart that I brought, it shows the cumulative net income for the big four banks. And in Q3, it was $18.8 billion. Now, that's a really nice increase from Q1 to Q2 on the back of lower provisions. But it is still down 20% year over year.
And if you think about a traditional consumer banking, it's struggling against these lower margins, which were down about 15 basis points sequentially. Now, that may not sound like a lot. But it is a really meaningful number. And then wealth and capital markets-- that just couldn't make up the difference. So despite the fact that the results were a little bit better than expectations, the underlying trends just weren't good enough.
- So were there any bright spots for you in the third quarter, as well as the outlook for the next year?
- Yeah, so that's a good question. And I guess the one thing that we haven't touched on yet is capital. If you look at the common equity Tier 1 ratio of the big banks at the end of the quarter, it was 12%. And JP Morgan actually put up 13%. These are really huge numbers.
And it just speaks to the fact that there's about $100 billion of excess capital versus regulatory minimums. And what this should do is give investors confidence that the banks will be able to weather any headwinds that come at them in the future from a capital perspective.
In terms of the outlook, we have had expectations that credit card spending is going to pick up in the next couple of quarters, and also that net interest income probably bottomed in Q3. And that would give the banks a good setup for next year, because NII is typically 50% to 60% of bank revenue. So those are some of the bright spots amongst the murky outlook.
- OK, so the big question as well now is what about valuations? Are they cheap right now, and could you see some improvement over the next coming months?
- Yeah, so it depends a little bit on which metric you look at. The banks are currently about 20% below their book value. And historically, that is an attractive level. But I would argue for a bit more of a focus on earnings and dividends.
On that basis, we're at about 11 and 1/2 times forward earnings, about a 3 and 1/4% dividend yield. That is somewhat attractive, but it's not a screaming buy. And I think to get valuations moving higher, you need to see that improvement in results, and consistency in the results. And frankly, it would also help if the US Federal Reserve were to allow dividend hikes, because then we could get that really exciting combination of dividend yield plus dividend growth.
- So putting it all together, what should investors keep in mind looking ahead?
- Well, I think that investors should remember that at some point, we're going to have a health care solution to this health care crisis. And unlike the global financial crisis, we can be pretty confident that the banks are going to get to the other side of this. So there's no need to panic.
But when I think about getting the stocks going in a meaningful way and improving sentiment, I think it just comes down to better results. And that would mean faster loan growth, higher margins, lower expenses. And I do worry that to outperform the broader market, we need to see all three.
And it's just a bit tricky to see how that will come together in an environment where interest rates are lower and you've got the potential for higher taxes and regulation. So for now, we remain somewhat cautious on the US banks.
- James, thank you very much for your time.
- Thanks a lot, Anthony.
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