Big Banks: Buy, Sell or Hold?
The country’s biggest too-big-to-fail banks have all reported second quarter earnings and the results were chock full of good news and bad news, depending on the bank and its banking model.
What the banks’ earnings, profits and losses tell us about the economy, about their health, and about the outlook for their stocks gives investors a window into the economy and how to play the banks.
A window into the economy.
Thanks to stimulus checks, enhanced unemployment benefits, the fact that consumers weren’t able to get out and spend, or were building up cash cushions, combined with proceeds from record corporate debt issuance, consumer and business deposits rose substantially in the second quarter at JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), Morgan Stanley (MS), and Goldman Sachs (GS).
Wells Fargo (WFC) was the exception, it saw deposits decline by 4%.
That cash cushion is a two-way street.
The extra $600 a week many unemployed workers are collecting ceases at the end of July. Other pandemic support programs are ending too. That’s a problem, as 31,400,000 Americans are receiving benefits. And although Congress is debating another round of stimulus or helicopter money, there’s no sign of additional help in the immediate future.
Corporations raised more than $2 trillion so far this year, mostly by issuing debt and some equity. That’s more than a 100% increase in issuance in just the first half of this year versus all of 2019. As long as the Federal Reserve continues to back corporate debt through its Primary and Secondary buying programs, corporations should see their debt securities hold above par.
However, if corporations come under more stress, investors may not be willing to lend them more and their debt securities could decline in value, putting pressure on their equity prices.
On the plus side, everyone’s cushion could be a positive for the economy if we get a vaccine or an effective treatment quickly. If the economy opens-up, consumers will spend their cushions and corporations with extra cash in hand will pay off debt and get back to growing their businesses.
But, if things turn in the wrong direction, as they appear to be doing with scary infection spikes hitting 32 states and businesses and recreation facilities being closed down again, consumption could dry up and corporations could lay off tens of thousands more workers and produce less.
The direction forward for the economy is critical now for the banks.
Goldman Sachs and Morgan Stanley saw extremely strong second quarter results with revenues and profits boosted substantially by aggressive trading and robust investment banking fees.
And while JPMorgan Chase, Bank of America and Citigroup had strong trading and investment banking revenues, their quarterly profits declined as they set aside billions more to provision for future loan losses.
Wells Fargo, with its tiny investment banking and trading operations didn’t get much help in the quarter from those divisions. They did, however, add substantially to their loan loss provisions and was the only bank that lost money in the second quarter.
Crunch Time for the Banks
If the pandemic subsides and the economy starts growing, all the banks are in great shape, except maybe Wells Fargo. All of them would be a buy right now, including Wells Fargo, on a somewhat contrarian basis, and as a long-term hold.
But, if the pandemic persists, the economy falls into a deeper than expected recession, and securities markets come undone, banks are going to get hard.
The banks that just hit it out of the park underwriting debt and equity issuance and trading, will see those revenues dry up and have to add more substantially to their loan loss reserves.
Big consumer-facing banks like Bank of America and Wells Fargo will see increasing loan losses and take hits accordingly.
Of course, there’s ways to play the downside too, if you know where to look and what strategies to use.
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The Long Game for Big Banks
Even if we’re headed in the wrong direction, I still think banks are worth buying here, with a provision.
Since my outlook is still mixed on the economy, but more positive than negative right now, I’d buy Morgan Stanley and Wells Fargo here, but not all at once.
I’d apply 20% of what I ultimately want to invest in each bank’s stock now and add another 20% when and if their stocks fall 5% and repeat that plan to amass a full position by averaging down.
If I see a turnaround, I’d buy up the remainder of shares I want and add JPM and BAC to my portfolio.
The banks are a long-term hold for me, especially Wells Fargo.
Morgan Stanley looks good to me because its less “consumer facing,” manages its trading and investment banking arms well, and has grown it wealth management business brilliantly. If the economy is on a healing track, Morgan Stanley will perform very well. If we’re headed in the wrong direction, Morgan Stanley just proved to me it’s got the right banking model to weather any storm
Wells Fargo is a mess, I admit it. And its stock proves that point. What Wells needs is to make wholesale changes across its top ranks and reconstitute its board. The right CEO at Wells would be like Satya Nadella taking over from Steve Ballmer at Microsoft. Ballmer was a bore, and worse. Nadella energized the company and moved its stock from below $40 to more than $200.
That’s my skinny on the banks.