JPMorgan, Citigroup kick off earnings season for big banks

Yahoo Finance’s Alexis Christoforous and Brian Sozzi discuss bank earnings with Fred Cannon, KBW Global Director of Research.

Video Transcript

ALEXIS CHRISTOFOROUS: When we know that bank stocks have been big underachievers this year. In fact, the S&P 500 financial index down about 19% year-to-date, bogged down by ultra-low interest rates. You've got credit worries and, of course, the steep economic slowdown. I want to bring in Fred Cannon now, Global Director of Research at KBW, a Stifel Company.

Fred, good to have you here this morning. I want to start with JPM, because they set aside a heck of a lot less money than they did the prior quarter for loan losses. But when you look at the possibility for a second wave of this virus, many say we're already in it, and a bunch of job cuts that just seem to be piling up, was that a smart move on the part of JP Morgan?

FRED CANNON: Well, you have to put it in context, Alexis-- and thank you for having me on-- and that is that because of an accounting change this year, all the big banks, all the banks really, put a lot of reserves in in the first and second quarters based on expectations of significant losses. What we're seeing is so far those losses aren't coming in. And while they brought the reserves down slightly, as Emily was talking about, they still have massive reserves for further problems.

Now, there are some real issues out there. There is the lack of a further stimulus bill-- remember, the CARES Act has been very beneficial to credit-- and a second wave, and these other issues. Nonetheless, because of that big buildup in reserve levels, they do feel pretty good right now in terms of what-- what's going on. And the other thing is consumers are paying their bills, despite the pandemic, which is a positive aspect of what's happened.

BRIAN SOZZI: You know, Fred, speaking of positive, so often, and you know this better than anyone else, the bank's earnings are judged on a sequential basis or quarter over quarter. And looking at JP Morgan, really they nailed it across the board in many of their segments, but specifically within consumer card and auto. What is their sequential improvement say about the pace of the economic recovery in the country?

FRED CANNON: Well, again, what it really says is that we are seeing the consumer reacting well. Both-- as you know, the savings rate's gone up to 25%. It's coming down a bit now. We saw a lot of loan growth early on, and that's creating some of those sequential numbers. But we have to really back up and look underneath these numbers a little bit.

And you have to understand that the banking system is still plagued by very low interest rates and very slack loan growth. And so as a result, what a lot of us are looking at is, OK, if we take out credit, if we take out trading and investment banking, what's the core earnings power here? And that still is fairly lackluster for the industry because of these extra low rates. And the fact is that some of these loan programs, like the PPP program, are going to phase out next year.

ALEXIS CHRISTOFOROUS: You know, Fred, I started this segment by talking about how bank stocks have been underachievers, and a lot of folks are looking to unlock some value there. But given the current environment, do you believe the larger bank stocks with a higher concentration in the capital markets, like Morgan Stanley, like Goldman Sachs, are better positioned to outperform in that sector versus banks with more retail and commercial exposure, like a Wells Fargo or a JP Morgan?

FRED CANNON: Well, really, what it comes down to, Alexis, is how dependent are they on their spread income, the difference between loan yields and deposit rates, because that's coming down across the industry. And to the extent that those banks are heavily dependent on that loan income-- I mean, spread income, that's where we continue to see some pressure. We think the valuations have reflected that, but clearly that's where the pressure points are. And so when we get later into earnings and away from the big capital markets companies like JPM, like Citigroup and focus on those banks that are more spread income, I think we'll see a little bit more challenging-- challenges, with the exception of credit, which we do think, this quarter anyway, will continue to be good across the industry.

BRIAN SOZZI: The complete opposite of JP Morgan continues to be Citigroup, really a bloated expense line, again, for this company. How big a task does incoming CEO Jane Fraser have to get this company running right again, also get the company back in the good graces of regulators?

FRED CANNON: Well, Citigroup has challenges, as you point out. There's no doubt that Ms. Fraser has challenges ahead. Citigroup has had a lot of deferred maintenance. We actually give Corbat some good marks for-- in terms of moving-- getting that company back into at least operating-- reasonably operating.

But in terms of being competitive with its big-- with JP Morgan and the other big banks, it's still got a ways to go. It's still got a ways to go on regulatory issues. It's continues to need tightened up there. And it still has a ways to go in terms of just the core profitability. If you look at the core profitability of those two institution, there's a huge gap, and she's got her work cut out for her.

ALEXIS CHRISTOFOROUS: I'm curious to get your thoughts on the election as it relates to banks, because they generally enjoyed a rollback of regulations during the Trump administration. That could change after November 3. We could see a more active Treasury Department, we can call it. How would you be positioning bank stock holdings ahead of the election?

FRED CANNON: Oh, great question, Alexis. I think that as we go into the election, I think a couple of things. One is we've actually seen in the past couple of weeks a reflation trade that has benefited the banks. This is actually somewhat similar to what happened after the last election. In other words, there was a view that there'd be a big fiscal stimulus, gets inflation going, steeper yield curve, good for banks.

The difference this time, which you point out, though, is if we have reflation it will be in a more regulatory environment, rather than a less regulatory environment. Obviously, that would be more negative for the banks. So there is risk there, there's no doubt. However, it's important to recognize that most of the regulatory regimes at these big banks were not set up in the last four years. They were set up during the Obama years.

And if you look at a lot of what they did and the way they're running their companies, they didn't really adjust to a deregulatory environment. They really maintained a lot of that regulatory infrastructure from the Obama years. And so while yes, it-- you know, incrementally is it-- is it negative, yes, for the big banks, I think that if we look at the way they position themselves, it's not as big a change as I think some people might think, just focused on a change in administration.

ALEXIS CHRISTOFOROUS: All right, we're going to leave it there. Fred Cannon at KBW, a Stifel Company. Always good to see you.

FRED CANNON: Great. Thanks for having me on.