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Inflation could be heaven or hell for banks: analyst

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Mike Mayo, Wells Fargo Senior Analyst, joins Yahoo Finance Live to break down the outlook for big banks, weigh in on broader markets amid the pandemic and discuss the outlook for the Fed’s monetary policy.

Video Transcript

[MUSIC PLAYING]

JULIE HYMAN: We were talking about the banks' negative performance last week, the large banks in particular really seeing a tumble. Some of them are coming back today. But still, investors are watching Fedspeak very closely. They're watching the yield curve, which has been flattening.

And Mike Mayo has been watching all this as well. He's Wells Fargo Senior Analyst. Our Brian Cheung is back with us as well. So Mike, I know you're watching all of this stuff. How are you thinking about where the banks are positioned right now? It seems like sort of a delicate positioning in the eyes of investors.

MIKE MAYO: Well, you have the Federal Reserve last week on monetary policy, and you have the Federal Reserve this week, Thursday night, you get the results of the annual Fed stress test. So we are wedged between two Fed very important moments. But last week, let's start with that, if that's OK with you, Julie.

JULIE HYMAN: Yeah, do it.

MIKE MAYO: OK. Well last week, there were three key words in the Fed announcement. It was right up front in the four-page release. And those three important words were inflation has risen. In fact, we've not heard inflation talked this much since really the 1970s.

So I brought my 1970s bag for you here. And in my 1970s-- in my 1970s bag, I have leisure suits. I have mood rings. I even have a disco ball. But you know, the '70s, we don't want everything from the '70s. We don't want-- I don't think we want the pet rocks. I'm not sure if anybody remembers those.

And we also don't want the bad inflation from the 1970s. And we also had bad inflation not only in 1974, but 1994, and that's when prices went up quickly. In 1994, the Fed was forced to raise rates very aggressively and unrealised, and then realized securities losses, derivatives losses, mismatches between the banks' assets and liabilities. So too much change too quickly could be a very bad dose of inflation.

But what I think I heard last week from the Fed is a good dose of inflation that's borne out of recovery from the pandemic. And last year, the banks had the biggest decline in their net interest margin in a century. So to the extent that rates rise, we think that that can start to reverse for the banks, so you get the benefits from better yield curve. And so that's what the Fed said last week.

And now Thursday night what we expect after the Fed stress test is a green light for banks to return a lot more capital, both dividends and buybacks. And in fact, we think banks will be allowed to return twice as much capital this year as opposed to the prior year. And remember, banks acted as a source of strength during the pandemic. They suspended buybacks, that was one action they took, so extra capital became even more extra capital. So that should be a very good catalyst come Thursday night.

BRIAN SOZZI: Mike, I can't tell if that's a leisure suit you're wearing. It's not blue, but I can't tell. You know--

MIKE MAYO: I might be wearing bell-- maybe bell bottom pants for the-- you know, they were in then too. So you know, you always have my--

BRIAN SOZZI: Keep the mystery alive. But I will notice this, you are-- you have buy ratings or overweight ratings on Bank of America, Citigroup, JP Morgan, and Goldman Sachs. Which bank stock do you really, really like out of those four to just play based on what you're saying in terms of inflation and the Fed?

MIKE MAYO: Well, we have-- we got more aggressive through the downturn last year, and we remain aggressive and positive on the banks. But our topic has been and remains Bank of America. We think there's both a cyclical and a structural story. Again, with the Fed announcement last week, if rates actually are going to go higher-- when I say rates, the federal funds rate.

If there's a greater chance that will increase sooner than expected, Bank of America benefits three times more than the average bank, $1.8 trillion of deposits. And these are sticky deposits. I mean, the average life of a relationship in retail banking at any large bank is 14 years. And people underestimate the benefits of a multi-distribution, multi-product, multi-geography business model like Bank of America.

So these customers, they could have customers for life now, whereas when I started in this business three decades ago, that was anywhere from the case. So Bank of America cyclically benefits. And structurally not only do you have this kind of lifetime value of customers, but they are one of the best fintech companies on the planet.

And their digital banking, it's not just about digital relationships. You know, we all measure that. It's the degree of penetration with each digital relationship. So whether it's online bill pay or deposit capture or depositing a check, I mean, they have metrics that are, like, 10 or a dozen different metrics they're going deeper and deeper. So Bank of America is our number one pick.

BRIAN CHEUNG: Mike, it's Brian Cheung here. Now the story for the banks, at least in the last few quarters, was that with the curve essentially flat with the rates on the short end back to near zero, you really got to rely on your trading desks. So fixed income and equities trading was the real cash cow for a lot of these banks that have big money center trading desks.

So that story, though, might be going away with volatility kind of disappearing from the market, although who knows if that's going to be the case over the next few weeks. But fixed income trading, we're already seeing it fall at Citigroup, for example, as of the first quarter. What do you expect to see in the second quarter? And how might that hurt the bottom line?

MIKE MAYO: Well, Brian, don't leave the play here. Broadway, I think, is opening in the fall, last I heard. And this is a three-act play for the banks. And act one was about the strong capital markets, especially fixed income corporations front loaded many of their financing needs, and that helped Wall Street.

But the second act involves benefits from loan growth, which is not here yet. It might not be here for two more quarters, but that's certainly coming. And act two, the capital return coming Thursday night, dividends and buybacks. So you have dividends, buybacks, loan growth in act two.

And then act three, if you want to stay for the whole show, is that the industry is driving toward the best deficiency in history. Post-pandemic tech-induced efficiency is quite amazing. And you've seen tech solutions applied to other industries such as retail and health care, and it's coming to banks.

And Plato had a lot to say about banking in the 21st century. I bet you didn't realize that, Brian. But what Plato said about banking in the 21st century is that necessity is the mother of invention. So banks have no choice but to become super efficient, and that will be act three over the next several years.

BRIAN SOZZI: Yeah, Mike, Brian was born in 1993, so he wasn't alive when Plato was just saying these amazing Instagram quote-type things. But switching gears here, we did have-- our staff has had a hardy debate on what Morgan Stanley CEO James Gorman said recently about returning to work, basically return to work or you may not have a gig or you may see your paycheck cut. What do you think about that stance by him and others on the stream? What is the outlook for banking jobs because of it?

MIKE MAYO: Well, look, I mean, you have culture, which is born in person. And so it's the spontaneous conversation. It's the water cooler talk. It's your creativity. It's the informal kind of conversations. That's what culture is made of. There's mentorship.

And there's also, especially for new employees, but new customers. So customers-- you know, if your customers-- if Morgan Stanley's customers are seeing their clients face-to-face, I guarantee you that James Gorman is going to have their employees go see their customers too. And it reminds me of this iconic 1990s commercial, airline commercial, where the manager said, we just got fired by a client. And he handed everybody in the room airline tickets to go see their clients face-to-face.

And I think post-pandemic, you're going to see an explosion, not only in visiting clients, but in entertainment face-to-face. And look, Wall Street is a hypercompetitive world. James Gorman and Morgan Stanley, they're hypercompetitive. They want to win. So it's not surprising that you see Morgan Stanley, especially Goldman Sachs and JP Morgan, all saying, hey, let's get back to the office so we can best serve the customers and nurture this culture that we have.

Having said that, I mean, there's likely to be some hybrid solutions if you're not customer-facing. And also, there's a war for talent. So it's not 100% forward. I mean, all the banks are trying to hire tech experts. And in a competitive world, you have to consider a work-life balance a little bit more. But as of right now, it's back to office for many Wall Street workers.

JULIE HYMAN: And Mike, finally, I want to ask you, as we talk about the sort of hybrid e-banking and living life in real life, you were talking earlier about Bank of America and its technological position. And we talked to a lot of sort of fintech startups on the show, whether they be banks or offering other services. How far away do you think we are from them chipping away in a more real fashion on the commanding market share that the big banks have?

MIKE MAYO: Well, I think you need to divide the answer into parts. And you have had fintech players chip away at banks. To some degree, banks were affluent mass market. And several fintech players went a level below that to the unbanked or the smaller customers where banks weren't paying as much attention. And that was a missed opportunity for banks. In addition, you've had fintech players obviously gain share in the payment space.

On the other hand, when it comes to the primary deposit or checking account, you're not seeing fintech chip away when it comes to the largest banks. And I think the most underappreciated aspect is what I said before. A multi-distribution, product, and geographic approach creates very sticky relationships for the banks, and that's what's underappreciated at the largest banks and the banking industry, as opposed to other areas of finance.

JULIE HYMAN: Yeah, I have personally been with the same bank for a long time, and I'm sure a lot of other people are like that for inertia's sake, if no other reason. Thanks so much, Mike. Appreciate your time. It's always a pleasure to talk to you. Next time, party at Mike's house with the disco ball. We'll all pull out our bell bottoms. Oh, he's pulling it up again.

[INTERPOSING VOICES]

Mike.

MIKE MAYO: Party next [INAUDIBLE].

JULIE HYMAN: Thanks, Mike Mayo, Wells Fargo, and our Brian Cheung as well.