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Bank earnings show ‘rates do matter,’ analyst says

CFRA Research Director of Research Kenneth Leon joins Yahoo Finance Live to discuss bank earnings, consumer spending, a 2023 recession, and the outlook for rate hikes.

Video Transcript

SEANA SMITH: Third quarter bank earnings are underway. JP Morgan, Citi, Wells Fargo all beating the Street's expectations. Shares moving higher here. As you can see, Morgan Stanley, on the other hand, falling short of profit estimates.

Joining us now, we want to bring in Ken Leon is CFRA Research director of research. And Ken, it's great to see you. So taking a look at these results, JP Morgan revenue up 10% here, Morgan Stanley missing expectations, profit off nearly 30%, Citi profit dropping 25%, although better than what the Street was looking for. It seems like Wall Street thinks banks are in pretty good shape. What do you think?

KENNETH LEON: So the third quarter was great because we got a really good snapshot that the US economy is resilient. The consumer is healthy. Business loans are going on. Of course, investment banking activity has really nosedived from last year. And the stocks were up a lot this morning, but they have really faded this afternoon because the real issue is 2023, we're going to go into recession. And it's really what will happen to bank performance, as we see some further weakening of the consumer. It hasn't happened yet in terms of delinquencies or bad loans. But the banks are adding some reserves.

And again, today's results is a good picture of what happened from July to September. The Fed's raising rates 75 basis in November, very likely again in December. That's a different narrative than a month ago when it was going to be going down to 50 basis points and then 25. So rates do matter. It will create some demand destruction, unfortunately.

RACHELLE AKUFFO: So, Ken, within the banking industry, then, what do you credit JPMorgan doing so much better than some of these other banks?

KENNETH LEON: Well, Wells Fargo also did well. And it's the real engine-- the beauty of banks is that when you have rising rates as it drives higher net interest income, widen spreads, you can just sit back, and so long as there's loan activity, you're going to show higher net revenue. Unfortunately, that probably will not be the picture in 2023 because loan activity is going to subside for both consumer and commercial and industrial loans.

So that really is what was expected. We did get that. Fourth quarter probably will be a decent quarter. But again, every time you raise rates, it's really squeezing the US economy more than before. And that's what the Fed has to do to get inflation under control.

SEANA SMITH: Ken, one thing that you mentioned in your note that stuck out to me was JP Morgan's head count. It actually went up 9%. We haven't really seen a reduction in head counts at the banks yet. As you talk about this uncertainty over the next several months, potentially a potential downturn here, what do you think that headcount will likely look like? Do you think we're going to start seeing some reduction?

KENNETH LEON: Well, it's a great issue, and JPMorgan, 9% increase in global head count. A lot of that is investing in technology software, taking on the disruptors of fintech, maybe something from blockchain. But again, you get these senior managements around the table in November. There's probably going to be some tactical cutbacks in investment banking because the book is not going to be there in the fourth quarter.

And the pipeline, even if you say it's there, it's not likely that we're going to see some V-shaped rebound in the first quarter of next year. I've been covering the capital markets for a long time. And this, unfortunately, is going to be a stretch where it's just going to be tough.

RACHELLE AKUFFO: And Ken, as we're looking at shares of Morgan Stanley under pressure today, you still-- you have a buy opinion on it. And you have a price target of $90. What is the base case there?

KENNETH LEON: Yeah, the base case-- so we downgraded Goldman Sachs a month ago from strong buy to hold. We kept Morgan Stanley as a buy, and our view was it was trading at a discount to names like BlackRock and Schwab. They're the leading in wealth management. They've got a high recurring revenue from wealth, but they still have an investment banking business.

So it's not our best buy rating, but we're going to stay the course. They also have the most dry powder for buybacks. And they had the most room from the Fed stress test last June. So I like what James Gorman and Morgan Stanley are doing. But I'm fighting uphill because the investment banking equity debt underwriting is not likely to be much better in the fourth quarter. M&A probably will tick up a bit.