Financial sector holds despite fears of new coronavirus strain

Yahoo Finance’s Alexis Christoforous and Mike Mayo, Wells Fargo Senior Research analyst, discuss banking outlook for 2021.

Video Transcript

ALEXIS CHISTOFOROUS: Welcome back. The Federal Reserve eased up on Wall Street's capital restrictions after determining the country's biggest banks are well positioned to handle another severe economic shock. And while the banks still cannot increase their dividends beyond what they paid out in the second quarter of this year, they can now resume their buybacks. And just minutes after the Fed's stress tests were made public on Friday, JP Morgan Chase and Goldman Sachs did just that.

Joining me now for a look at the banking industry is Mike Mayo, senior research analyst at Wells Fargo. Good to see you, Mike. Were you surprised that the Fed eased up on the lenders, I mean, especially given the optics around Wall Street buybacks during this particular time, during this pandemic?

MIKE MAYO: Well, this was a remarkable stress test by the Fed. It was the most harsh Fed stress test in history. They have unemployment almost doubling from where it is today. They have stress scenario losses of $600 billion. That's one third of the industry's equity. And banks still have enough equity to exceed the minimums by one third, even under this stress scenario.

But that was not a surprise to me. You know, I've done the math. Banks are resilient. The surprising part was that banks are now allowed to pursue buybacks after a nine-month moratorium.

And so what I see this as a key marker on the road to redemption from the financial crisis for the banks. The Fed itself is saying that banks are resilient, that they're strong, that it's night and day versus the global financial crisis. Then, we were talking about banks needing to raise equity to shore up their balance sheets. Now we're talking about banks buying back stock. What a difference a decade makes?

ALEXIS CHISTOFOROUS: Absolutely. So when you look at the banking landscape, Mike, which banks do you think stand to benefit the most with the resumption of these buybacks?

MIKE MAYO: Well, absolutely the standout here is Goldman Sachs. Goldman Sachs is able to buy back more of their shares as a percentage of their market value than any other bank. That's just the math. They also trade at a cheaper valuation. So when you're able to buy back your stock at cheaper prices, that's a good thing.

And there was a change in the implied minimum capital level. It's not official by the Fed, but based on our computations, that minimum level really has gone down for Goldman Sachs. So better lucky than good. Or maybe it's both at Goldman Sachs, to be truthful.

But they sold off-- or they're still in the process of selling off their private equity investments. And what a great stock market to do that in. So they're harvesting these past investments, they're getting gains on those investments, and that's the area of the biggest hit to capital, so to speak, for these banks.

So the world's kind of coming back around to Goldman Sachs in many ways. And we think Goldman Sachs' stock hit its all time high over the next few quarters.

ALEXIS CHISTOFOROUS: You know, the Fed is committed to keeping rates lower for longer. This we know. Traditionally, that is not the most friendly scenario, friendly backdrop, for the banks. Why are you so bullish-- if that's what I'm hearing here-- why are you so bullish on the sector in 2021? Are they just due for a bounce back?

MIKE MAYO: Well, the big day was Pfizer Monday, November 9. And before Pfizer Monday, bank stocks had the worst underperformance versus the market year over year in history. Since Pfizer Monday, the past six weeks bank stocks have outperformed the market by 16 percentage points. So to some degree, as goes COVID, as goes the bank stocks to the extent that you have a vaccine, and there's light at the end of the tunnel.

Then, the biggest pain is still to come for consumers, small businesses, corporations. But the extent of that might not be as bad as expected. And that means banks, which have already set aside reserves for these future problems, may have set aside too much in reserve. So when it comes to credit, that certainly looks good.

And you're absolutely right. The revenue pressures are not going away. But necessity is the mother of invention, and banks are finding new ways to become a lot more efficient. And so we think banking could have the biggest structural changes in history due to technology. And you're likely to see expense control get better over the next couple of years as well as credit.

ALEXIS CHISTOFOROUS: We know that this year has been a very strong one for merger and acquisition activity. We're expecting that to continue into 2021. What kind of support is that going to lend the banks? And again, who in particular can benefit from a robust M&A activity?

MIKE MAYO: Well, I mean, right now all roads go back to Goldman Sachs. They are a leader in mergers and acquisitions. And to some degree, mindshare with their clients is translating into market share during this time where really, capital markets are going from what had been a defensive positioning-- go back to March and April and that's when Goldman and the banking industry stepped in and met a surge in loan demand liquidity. It was all about defense. Now we're talking more about offense. You're seeing IPOs, you're seeing more merger activity. And so Goldman once again is positioned to do well.

But we do think that the largest US capital market players, which have gained share for the last decade continue to do so and that you have cap and market stronger for longer. So you also have the likes of Citigroup, Bank America and JP Morgan benefiting from that trend.

ALEXIS CHISTOFOROUS: What about on the flip side, though, of them? And I understand the investment banking giants, like Goldman, like Morgan Stanley, stand to benefit. But what about the retail-oriented banks like Wells Fargo? You just mentioned Bank of America. What's your outlook for those banks, companies that are more retail focused in the new year?

MIKE MAYO: Well, first I don't comment on my firm, Wells Fargo, who I work for now. I'll say I'm-- I'm a happy employee. It's my seventh brokerage firm. I'm just one of 260,000 employees. But it's a great place for me to work.

But having said that, traditional banking revenues have been under pressure. We estimate that the low interest rates have been the equivalent of a $50 billion tax on the industry due to the biggest decline in the net interest margin in a century. So it's taken a toll. And it's still likely to be taking a toll, a headwind.

Having said that, the worst is over. You're seeing a leveling out of those traditional banking revenues. But it's still not a source of any great growth. So it comes down to doing more with less, assuming modest growth once we get out of this pandemic, and then really controlling your expenses with the-- the aid of technology.

And my eyes were opened three weeks ago. I attended our firm's technology conference put on by my colleagues. 185 different tech firms-- big tech, small tech, private firms-- all advising industries on how to become more efficient. And I had an "aha" moment. I'm like, this has already taken place in retail, in health care, and other places. Now it's just a matter of getting banks on that-- that train of deploying these tools that are already out there to become a lot more efficient to, as you point out, confront these revenue pressures.

ALEXIS CHISTOFOROUS: All right. We're going to leave it there. Great insights as always, Mike Mayo of Wells Fargo.