Head of U.S. Bank Equity Strategy on the 'number one issue investors are wrestling with' during Q2 earnings
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As earnings season kicks off with a slew of big banks reporting results, RBC Capital Markets Managing Director and Head of U.S. Bank Equity Strategy Gerard Cassidy joins The Final Round to discuss what these numbers mean for markets.
Video Transcript
SEANA SMITH: That. I want to move on to the bank earnings, because that's the big thing that investors are watching or were watching in the markets today. And then, of course, as we get a few more results later on this week, JP Morgan, Citi, and Wells Fargo, they were the banks out with the results this morning. JP Morgan and Citi posting better-than-expected numbers. But both setting aside billions of dollars for loan losses.
Wells Fargo, on the other hand, reporting a $2.4 billion loss, slashing its dividend. That stock on a pretty significant amount of pressure today. For more on this, I want to bring in Gerard Cassidy's RBC Capital Markets managing director and head of US Bank Equity Strategy.
And Gerard, let me get your take just on the results that we saw today, because I know ahead of the numbers and a note you warned that this quarter was going to be confusing. It was going to be sloppy and was going to be shocking for some banks. So what did you think of the numbers that we got today and also just the market's reaction that we saw to these results?
GERALD CASSIDY: Sure, thank you. I would say that the results we saw today fit the description that we described that you just reiterated that we said last week. They were surprising, shocking in some cases, and sloppy. And every bank is going to be a little different. And as you pointed out, the JP Morgan and Citi numbers-- it was a tale of two cities.
Capital markets numbers very, very strong. Even on the residential mortgage side, very strong for JP Morgan. But both of them had elevated levels of loan loss provisions in anticipation of greater credit losses later this year. Wells, on the other hand, it was a terrible quarter unfortunately. The company is really stuck between a rock and a hard place.
They had to take their medicine. They did. They built up their loan loss provision quite dramatically. As you pointed out, they cut the dividend. And they still have a lot of heavy lifting to do to get out from underneath the asset cap that has been imposed by the banking regulators. That asset cap has really put them in a tough position because they can't grow their way out of the margin pressure that they're seeing. And the other banks can.
So when the spreads decline, which is what we saw in the quarter, the banks, like JP Morgan and Citi can grow their balance sheet to offset some of that pressure. Wells cannot. And that's really hurting Wells at this time. But the other two banks-- the JP Morgan capital market numbers were unprecedented. Phenomenal trading numbers in FIC trading in particular. And Citi had very good numbers there as well.
SEANA SMITH: And Gerald, I wanted to ask you about Wells Fargo. Can you drill that into what you were saying just in terms of the fact that their revenues obviously have been under pressure because they haven't been able to grow. It's had a significant impact clearly as we've seen on their earnings potential as well. But do you think at this point that most of the bad news related to Wells Fargo is out? And do you see any reason for an investor to own Wells Fargo right now?
GERALD CASSIDY: It's a really good question and the right question to ask. We're talking to our traders late today on this very issue. And I would say that it's still a little too early. And part of the reason is we need to see the strategy that their new CEO Charlie Scharf is going to implement. When he came on board last fall, he indicated in January of this year before COVID, of course, that he was going to put out his strategic plan for where he was going to take the company sometime between third and fourth quarters of this year.
He reiterated that today. So I think we need to see the capital strategy-- the business strategy that he's going to bring forward later this year. He pointed out on the call today, they know their expense level is too high for when they compared themselves to their peers. So expenses need to come down. Possibly $10 billion is a number that was talked about on the call. But it's going to take more than that. It's going to take revenue growth. And that's going to take the asset cap having to come off.
We don't see that happening until late next year. So as a result, the company is still going to be in a bind for quite some time. So I think it's a little early. A lot's been discounted as you pointed out in the question. But I don't think it's the time right now to jump in. There are other alternatives if you want to own large cap banks that could give you the upside without running the risk of a bank not being able to grow.
RICK NEWMAN: Hey, Gerard, Rick Newman here. Those loan loss provisions you mentioned earlier-- in plain English, that means more people and more businesses are going to default on loans. They're not going to be able to pay what they owe. What did you learn from what the banks expect the economy to be like in coming quarters from what they had to say about defaults on loans?
GERALD CASSIDY: It is the $64,000 question. And what's interesting is that in all candor, none of them really know. Diamond referred to it as being a murky quarter or the murky outlook I should say. Certainly Corbat over at Citigroup, he was certainly very cautious and as was Charlie Scharf at Wells Fargo, because nobody knows what the ultimate outcome will be for the virus-- the COVID virus.
That's, of course, having some flare ups in states like California, Texas, and Florida. And that's having repercussions on their economy. And so it's really what one's view is of the second half of the year. And if we can navigate and grind through this problem with the COVID virus, and there's not a second wave of any material proportions, then I think you'll see the economy obviously behave a lot better.
So they are building up the reserves in anticipation of some really tough numbers. Nobody's expecting to see positive real GDP growth this year. Everybody is still expecting to see high levels of unemployment around 10% or slightly give and take 1/2% from that level. So if we go into a second wave of the virus very hard, and this country's economy stays in a recession into the fourth quarter of this year, then the provisioning is not high enough.
On the other hand, if this economy starts to show real momentum following the bottoming out in June that we've seen and that momentum continues into the end of the year, then they put up too much in reserves. So it's a tough call right now. And that's why the stocks trade the way they do. They're super cheap relative to the market on our price-to-book-value basis. But everybody's just uncertain about what the outlook is going to be for the banks over the next six months.
AKIKO FUJITA: Gerard, let me pick up on that point because I thought it was quite telling. JP Morgan CFO saying that June and May, we're going to have the easy months in terms of the recovery. Now we're entering the moment of truth. And to Rick's point, you know, the expectation of defaults-- this wave that's coming right now, how much of that outlook is contingent on additional government stimulus?
There's so much debate about whether to extend the unemployment insurance-- extend some of these moratoriums as well. How much of government policy that you think could play a role in changing that outlook?
GERALD CASSIDY: It's really interesting, because we're in such an unusual time on credit because normally in a normal recession, you don't have the government intervention as quickly as we had this time and certainly not of the magnitude that's going on. And so the forbearance numbers, which is a new term, you know, right now, the banking industry has granted forbearance to a number of consumers.
And as a result, those loans are not considered to be problem loans. And, therefore, we will not know the real true number on the credit problems until the forbearance numbers expire, which will probably take place in the third and fourth quarters. But to your point, if the government comes out with another stimulus plan, then maybe it's not an additional $600 a week in unemployment benefits then unemployed people who will receive. Possibly it's half of that.
But even still, that is going to be very beneficial to the banks in that the consumers will be able to still maintain their payments even though they've asked for a forbearance. And that's the other thing. When you look at the forbearance numbers, many of the consumers that have asked for forbearance are making their payments. They just want to have the optionality. And if they can miss a payment, they could do that in the future.
SEANA SMITH: And Gerard, I want to go back to a point that you were talking about earlier when you mentioned with Wells Fargo and just really as the amount, talk about the financial sector as a whole, because we have seen the action that we've seen in a lot of these bank stocks. They're obviously out of favor in this market right now. They've been massive underperformers. What do you think it's going to be? Or what do you think investors are looking for in order for these banks to come back into favor and for these investors to finally decide that, hey, now these are the stocks to bet on?
GERALD CASSIDY: I think the number one issue that investors are wrestling with is really the short-term outlook. I think many people have concluded that similar to other periods of time, the US has gotten through these terrible pandemics. And the economy will recover. So the long-term outlook people can, I think, reach.
However, it's the near term. How severe will these problems be between now in the first quarter of next year? So as soon as investors can gain more confidence that the economy is not going to go back into a recession-- we're not going to have a W, or we're not going to have some sort of L-shaped recovery this year. And there really will be economic growth in the third and fourth quarters.
The moment that can crystallize and then investors thinking, that's when these stocks could really start to work. And that's a hard call. I don't know if that's literally in the month of August or the month of October. But it's certainly going to be between now and year end that investors will be able to determine once and for all, the economy's either yes, it's in full recovery, or no, we're back into a recession. And obviously you don't want to own the banks in the latter. But you do want to own in the former type of scenario.
SEANA SMITH: Yeah, that is a question that all investors, I think, are asking themselves at this point. Gerard Cassidy, RBC Capital Markets. Thanks so much for taking the time to join us today.
