Gerard Cassidy, RBC Capital Markets Analyst, joins The Final Round panel to discuss what he thinks of the markets and break down the big bank earnings reports.
Video Transcript
SEANA SMITH: Welcome back to “The Final Round.” Third quarter earnings season is underway. We got results from Citi and JP Morgan before the bell this morning. Both banks beating the Street’s estimates here. But shares of both of them are in the red today. We have Citi closing off nearly 5%, JP Morgan dipping just round 1 and 1/2%.
So for more on this, we want to bring in Gerard Cassidy. He’s RBC Capital Markets managing director, also head of US Bank equity strategy. And Gerard, great to have you on the show. It was a good quarter for both companies when you take a look at the fact that, at least, they beat the Street’s estimates.
Yet, stocks are down pretty significantly, especially in the case with Citi, with that stock off just around 5%. Why are we seeing this reaction today?
GERARD CASSIDY: Well, there was a couple of reasons, Seana. For Citi, in particular, the reason that we saw the stock come off as much as it did was they also announced last week that they had some enforcement actions that they signed with the banking regulators. And this has to do with the internal controls and procedures.
And they had to point out today that there’s going to be costs associated with fixing those problems. And I think what investors discovered was that it’s not going to be a very quick fix. It’ll take some time. And we don’t know yet how much it will cost.
But in an environment where revenues are challenged, as they might be next year for the group, that has made people very concerned today, which is why I think the stock was off more than JP Morgan. On the JP Morgan news, and Citi, to your point– and you’re accurate– both at Citi and JP Morgan, bottom line numbers better than expected. And it was driven by improved credit numbers for both those companies.
But what happened with JP Morgan and also with Citi, in addition to the Citi issues that are specific to Citi, investors are looking through the credit improvement stories and are looking at revenue growth for 2021. In this low interest rate environment, it makes it challenging to grow revenues from lending and investing in securities because the margins are coming down due to the fact that the yields in the portfolios when they pay out and have to be reinvested, those yields are lower than where they are today.
So that’s bringing down the margin. So that’s really, I think, the story with the banks today. The readthrough on credit very positive. However, people looking beyond that now are looking at net interest revenue, lending revenue, and they weren’t as sanguine about that outlook.
SEANA SMITH: Yeah, Gerard, it was interesting because the loan loss provisions, one of the things that you mentioned there, it was one of the, I guess, focal points here of analysts on the Street when we were starting earnings season.
And especially when you take a look at what JP Morgan reported, it was much better than expected, setting aside less than what the Street was fearing that it would need to. What do you take from that, just in terms of more of a macro picture and what it’s telling us about the economy? Is the economy in better shape than maybe we had feared it was?
GERARD CASSIDY: It’s hard to say. It’s a really good question because it gets to the heart of the matter. And the banking sector changed their accounting procedures at the beginning of this year. The so-called CECL accounting, Current Expected Credit Loss accounting. And this accounting requires the banks to build up their reserves for expected losses through the life of the loan portfolio.
And as you know, in the first and second quarters of this year, when the pandemic was at full strength, it was very dire. And the banks really built up their reserves quite substantially. Now that it’s died down a little bit, it’s obviously not out of the woods yet on the pandemic. But what it has done is that the reserves have already been established. And now we’re waiting for the credit losses to come.
And so what we saw today from both these companies is that their outlooks for the economy in the second quarter were more negative than they were today. They improved slightly, not dramatically. But they did improve slightly, which helped on the reserving for these future loan losses.
What’s really going to be the tale of the tape, I think, on the future from the credit losses will be the strength of the fourth quarter and first quarter economy. We all know the third quarter number is going to be incredibly strong. And it’s more of a mathematical exercise than anything else. But the real test will come, assuming the virus comes back in our flu season here in the United States.
I would suggest that if we can put up 2% to 3% real GDP growth in the fourth quarter and first quarter of ’21, that will be very positive for credit. And the outlook improves even further, which means there will be lower costs for credit going into ’21 under that type of scenario.
RICK NEWMAN: Hey, Gerard, Rick Newman here. Could you go into more detail about those credit losses you mentioned? What is coming? Is it just a blip in the stream of defaults and other types of stress? Or is it a tsunami or somewhere in between? And do the banks have ample buffer zones to handle this?
GERARD CASSIDY: Yes, Rick, they do. They have plenty of capital, but more importantly, also, plenty of reserves. But it’s an interesting point you’re bringing up because the traditional metrics are not following the way– the patterns that they’ve followed in the past.
And when you take a look at the connection or the joining at the hip, if you would, of unemployment and credit card delinquencies, when unemployment goes up as much as it has risen in this downturn, you would expect the credit card chargeoffs and delinquencies to rise for the banks, and they haven’t.
And that’s, obviously, partly due to the fiscal stimulus where people that were unemployed were receiving $600 a week in incremental benefits. And according to the University of Chicago, you know, 2/3 of those people were earning more money unemployed during the downturn than when they were employed. So they were able to make the payments.
So the connection between the two is not holding up the way it normally does. And so the banks are wondering, you know, now that the unemployment benefits have been scaled back, we are yet to be back at full employment, as you know. So they’re worried about these individuals that were making payments before may not be employed today and may end up defaulting sometime in ’21.
So they’re not– they’re being cautiously optimistic, but they’re not suggesting at all, nor are we, that we’re out of the woods on credit. It really will be highly dependent upon how strong the economy becomes in 2021.
SEANA SMITH: All right, Gerard Cassidy of RBC Capital Markets, we know it’s an extremely busy time for you with all these bank earnings rolling out, so we appreciate you taking the time. We’ll talk to you soon.
