Bank earnings: Fed rate hikes creating ‘normal friction’ for financials, analyst says

JMP Securities Director of Financial Technology Research Devin Ryan joins the Live show to discuss bank earnings and the outlook for financial stocks amid Fed tightening, volatility, and the macroeconomic backdrop.

Video Transcript

AKIKO FUJITA: Let's turn our attention now to Brian's favorite topic. We're talking about banks. Financials trading pretty flat right now, but we did see some big moves on the back of earnings from Morgan Stanley, Citigroup, Goldman Sachs, and Wells Fargo, by the way, the biggest laggard on the day among the banks that have reported so far. Let's bring in Devin Ryan, JMP Securities analyst. And Devin, let's just start broadly here because I know you cover Goldman and Morgan Stanley specifically. Looking through the numbers, what stood out to you?

DEVIN RYAN: Sure. Well, what I would say is that 2022 has started complete opposite of what we saw throughout all of 2021, where 2021 was all about investment banking and asset prices appreciating 2022. On the other hand, investment banking activity was incredibly slow. The pause button was hit. Equity issuance was down 70% year over year. But, you know, I think what you saw is the resilience of these business models, and there's a lot of natural hedges. Trading was very strong. And now we're moving into likely a higher interest rate cycle. And so you get a lot of balance.

And I think that came through, where results were still very good overall against what was probably the most challenging backdrop since the beginning of 2020, as the pandemic started. So very encouraged. You know, and we could take a step back. I think the macro backdrop is number one conversation piece for investors. And that's not a great moment for financials, but you've also seen pretty big pullbacks in the stocks.

And so we're actually looking at some of the names like Goldman Sachs here. The bar was high, heading into the year when the stock was around $400. Now at $320, I think investors will do quite well. And I think you saw what was, again, a very strong quarter with a 16% return on tangible equity. The stock is trading at 1.2 times tangible book value. So that's a good relationship where, over time, investors tend to make money.

BRIAN CHEUNG: Yeah, Devin, it's Brian Cheung here. I mean, you saw James Gorman kick off his remarks in the earnings results, saying market volatility, economic uncertainty. And we're seeing this across all the banks. The consumer facing banks not getting as aggressive with paring down their allowance for loan losses, for example.

So you're starting to see the banks at large maybe prepare for not necessarily recession, but just harder times in the quarters to come. What did you see in the bank earnings that tells you the degree to whether or not this is just the first quarter of 2022 or a trend that's beginning that could impact earnings in the quarters to come as well?

DEVIN RYAN: Yeah, Brian, it's a great crystal ball question. What I would say is we've seen this movie before. And what I mean by that is that we've been through many periods of market volatility and uncertainty. And ultimately, we come out on the other side. The question I think you're asking is, when does it stop? And that's a crystal ball question around what's going to happen with the outcome of Ukraine, how the market can absorb kind of the reversion in monetary policy.

And so that will likely drive some volatility. But when we take a step back, we look at the financial health of the banks and even of the economy right now. The consumer is in a great spot. Less than 4% unemployment, very strong balance sheets. They're spending money. So yeah, there could be a little bit of disruption here on the corporate side, with the cost of capital moving higher with rates. That can create a little bit of friction, but this is kind of normal friction. And I think we get on the other side of it.

So if you're an investor and you think we're going into recession, you know, stocks overall tend to not work very well into that environment. Financial stocks may hit a hiccup here as well. But as I mentioned, we've already pulled back quite a bit from where we were heading into the year and kind of the highs. You know, Goldman Sachs was trading well over $400. Last year today, it's around $320.

So your starting point is setting you up for a much better risk-reward and the reason being is that in reality, normalized earnings power hasn't changed at all. You may be impacted at the very near term. But as you think out over the next year or two years, three years, it's effectively the same level of earnings power, but you're now buying the stocks at a pretty material discount. So that's the way I would frame it. It's tough to say what's going to happen today or tomorrow, but we are seeing some encouraging signs around a moderation in volatility.

And then the last part I would kind of point out here is, I mentioned equity issuance down 70% in the first quarter. I do not believe we're going to end the year down that high. Eventually, companies come back and they transact, even if markets remain at lower levels. So typically, in the onset of volatility, you'll see M&A slowdown. You'll see ECM slowdown because people need to readjust and assess what's happening at that current moment and reassess new prices.

But ultimately, companies need to raise capital. There's a very strong, I think, support for why companies need to do M&A and make strategic decisions. So the world's going to move on. And, you know, now you're able to buy some of these really good companies at a much bigger discount.

BRIAN CHEUNG: Now, we were kind of getting a picture on the consumer, at least for right now. We saw that, for example, Wells Fargo-- I know you cover the more investment bank centered banks, but mortgage lending was down on that front. We're seeing rates go up across the board at the longer end of the curve. So it's not just the mortgage rates, which we've seen tilt above 5% just today, but we're seeing the 10-year, the 30-year ripping higher. How do you think that impacts the bank performance, as we know it's been very important for their trading desks, at least at Goldman and Morgan, to try to work against the big movements that we've seen in rates?

DEVIN RYAN: Yeah, so a couple of things. One, it really depends on your business mix. So no doubt, areas like mortgage lending, that will potentially slow. Refinance activities slowing here, just with higher rates. But, you know, I think taking a step back, we're not going, at least in my opinion, to kind of a new level of rates. We're going back to where we came off before the pandemic and maybe marginally higher.

But, you know, I think in that environment, if you remember heading into 2020, it was still a very constructive backdrop, both from an economic perspective and also for capital markets. A couple of hundred basis points higher in interest rates isn't going to dramatically curtail M&A activity. As asset prices settle down, companies will come to market with issuance. And there's a lot of very good companies that I know are looking to go public. So all of that will resume. And then on the other side, as volatility inevitably subsides, trading results will likely slow down a bit.

And that's just, again, the natural hedge in this business model, which is why it's a good business. And then that's even beyond talking about where all these companies are really leaning in around growth. And I don't expect that's going to change at all. I think Goldman Sachs talked about today, they're not changing their strategic roadmap.

They're going to continue to lean in on all these new areas on consumer and transaction banking. Morgan Stanley is doing a heck of a lot in their wealth management business and on the retirement side. And so there's a lot of exciting growth still to come here. And we're just working through a little bit of a macro volatile backdrop.

BRIAN CHEUNG: Yeah, and by the way, bank earnings not over. Bank of America on dock for Monday. But Devin Ryan with the breakdown, at least for today's earnings, director of financial technology research at JMP, a citizen's company, thanks so much.