Banks At Cycle Top, Will Be Down 30-50% In 12-18 Months: Peabody

of a percent right now after reporting quarterly results. Here to tell us more about those results and the banking industry is Charles Peabody. He is the president of Portala's Partners. Charles always a pleasure give us the details when it comes to Bank of America and maybe just provide the context for how the bank is performing. Sure, well it was.

It was a solid quarter um, but like other banks, the reported earnings were probably higher than what we would call core earnings as they included a number of unusual items. Two that can be called out was about a two cents share benefit from text benefits and a one cent um you know, goose from reserve release. So that's what you're generally seeing is that the core rains are coming in below the report earnings, but I would say the

corens are in line with with expectations. This are these the best core earnings were likely to see in the cycle. They are, and I think that's why the stocks are reacting UM in a negative fashion to these. What are on the surface strong reported numbers is we're seeing what

I would call low quality of earnings UM. The earnings strength is coming from large trading gains, which is a low pe revenue source, and they're coming from reserve releases, which you know investors aren't going to pay up for at the end of an economic cycle, and some unusual

accounting gains. So in that context, if you have a situation where interest rates are moving higher because of either a strengthening US economy or increases from the Federal reserve, that should help the net interest margin of the bank. No matter how the bank is really run, it will and it has um. But what what we're looking for at this point of the economic cycle is what i'd

call the second derivative, the end of cycle dynamics. So take your comment about higher rates, Yes, it is going to help net interest margins in net interest income, but we're past what I would call peak optionality in terms of the benefits of higher rates. So, for example, um back in two thousand and sixteen, Bank America would have seen about a seven billion dollar boost to their net

interest income from a hundred basis point rise in interest rates. Today, that's about three billion JP Morgan and they're called Marion Lake the Sea Fox said that they're one point seven billion last quarter, would be material lower from a right rate hike, and that's down from three billion in two thousand and sixteen, So that the optionality that the margin is becoming less and less favorable. Add to that, issues of credit card charge offs are they rising? They are,

and you know they're rising. You know what the analysts are calling in a benign state, but they are rising. And that's the other um end of cyclodynamic is usually you see cards lead other categories in terms of deterioration, and we are definitely seeing higher losses. Although it's been coined in the in the phrase of you know normalization, Yes, well that's that's it's a nice word. That's why that's why they get to use it. Lending against inflated asset values.

Do you consider that to be a risk? I do, and that that's more on the on the wealth management side and on the corporate side. So in wealth management, one of the drivers of revenues is what we call securities based loans and jumbo mortgages and um, you know, I think we're going to see much more volatility in asset prices, where certain assets values could deteriorate literally overnight. And we saw that with the stein Hoffman in the

fourth quarter. We saw that more recently with rousel Um, the aluminum company in Russia, and how either geopolitical events or economic events can cause the value of those assets to change very rapidly. And yet banks have made significant loans against these inflated asset values. And as rates move higher, I think it's gonna be tougher to sustain these asset values. Is it tougher for even experts to understand what's going on at large banks because there are so many unusual

items that are reported on a quarterly basis. Yeah, this quarter was a very messy quarter because you new accounting adoptions that change to the values of equities. For example, you had tax benefits, you had lone loss reserve releases, um, you had asset sale gains there there it was a messy quarter, and that that has made it difficult, you know, short term to to understand what is truly core and

underlying trends. Okay, so it seems to me that you're not just talking about the business at Bank of America but at all major banks. Is that correct? That's correct, But but there are some themes. For example, Bank America's revenues were up, you know, two and a half percent year over a year, So we're seeing low single digit revenue growth pretty much through all these big banks except for JP Morgan, which had much much stronger revenue growth.

You're seeing reserve releases, you know, because of improvements in the energy portfolio and improvements in residential real estate. So there are some common themes. Expensive control remains very tight. They're doing a great job on expenses. And then see income remains weak outside of trading. And that's important because at the end of the cycle, you see a couple of things that that says we're at the end of

the cycle. On on the trading front, you see a rotation from thick to equity as the driver of kapital markets revenues, and you saw that in this quarter equity was very strong. Thick was a little weaker, although solid, and then on the on the underwriting side, um, you see, you know, a shift as well. So we're seeing all the typical signs of end of cycle dynamics. So just quickly, Charles, all things being equal, if you aren't an investor in banks,

should you just wait for a better time? I think so. I think we're in the topping process in the stocks in the first half of this year, and we'll enter a bearer market in these stocks. You know, a year and a half from now, two years from now, we'll be down from their peaks. Thanks very much, Charles Peabody, always a pleasure, President of Portalis Partners, talking about the US bank industry. I'm pim Fox. My co host Lisa Abramowitz is off today. Joining me now is Brian Egger.

He is our senior Gaming and Lodging analyst for Bloomberg Intelligence. You can follow him on Twitter at breaking Call. And El Dorado Resorts and the real estate company Gaming and Leisure Properties. They are teaming up to buy carl Icons Tropicana entertainment price tag one point eight five billion dollars. Brian, why is carl Icon selling Tropicana Entertainment if it's such a good business, remember that Carlican has actually been selling

his gaming interests over time. Uh. He basically had owned Trump Entertainment Resorts and ceased the operations of the Trump Tasha Hall back in sixteen, sold that property in seventeen. It's not reopening. So basically what this does is carl Aicon gets a billion eight five in proceeds and ends up effectively divesting his casino interests, which turns them over at Eldorado Resorts, which has the advantage of be able to get all these cost savings and synergies from doing

this deal. Why are they able to cut costs when carl Icon is not, Well, it's basically because El Dorado has an existing base of operations, partly through the acquisition of Alfpre Casinos last year. So with a larger base of operations, you can basically reduce combined corporate overhead, get

eventual marketing synergies. And what they hope to do with this deal is reduced the costs at the Tropicana Entertainment entity by about forty million dollars and basically take their purchase multiple down to like the five to five and a half times Ebadar range, which is quite attractive. So it does make sense for El Dorado and gives them some cost savings opportunities Gaming and Leisure properties. This is the partner with El Dorado Resorts that is making this

deal there, that's just a real estate investment trust. They have been on the acquisition trail as well. They bought Pinnacle Entertainment back in sixteen, right, that was nearly a two billion dollar deal, right, So basically they own the real state of both Pen National Gaming and most of Pinnical Entertainment properties. Pinnacle itself as being acquired by Pen National Gaming in terms of the operations in the second

half of this year. But as you mentioned Gaming Leisure properties as a reets, uh, they have the real estate assets here. So basically the way this deal works is that Eldorado is paying about sixty million dollars for the operations and that Gaming and Leisure is paying about a billion two for the underlying real estate. So you're really having kind of a separating the real state from the operations in this combined transaction. All right, So where does

all this money come from? And is it money? In other words, why would you want to be buying if someone is supposedly as smart as carl Icon is selling right. So there's no doubt that Atlantic City has been a challenging market. UH. The two casinos opening up the summer, the Ocean resort UH and the hard rock properties I think could galvanized tourism. But they also come at a time I adding capacity to an already crowded Northeast gaming market.

So I think the way El Dorado thinks about this in Atlantic City, which again is only of the cash flow of Tropicana Entertainment, is they probably increased the but dire fermenting some cost savings. They don't deny the fact that that particular market is challenging. Now this could change if UH the Supreme Court authorizes understructured sports betting across the country, in New Jersey and elsewhere, that could create a traffic driver that heretofore has not existed in Atlantic City.

Based on your knowledge of the industry, do you believe that that is what many investors are betting on, this unrestricted sports betting. That's certainly a part of what the m and a interest in both Pennsylvania UH and New Jersey has been about been about. Now if you look Atlantic City, they had about twelve casinos a peak there, down to seven this summer will be up to nine again with two new openings. So we've shaken that market out already. We've cut it almost in half, and it's

much healthier today, albeit on a much smaller scale. Two new properties opening the summer depends on whether or not they'll drive enough traffic to the city through entertainment to galvanized tourism and increase overall results. But there's no question the Northeast mid Atlantic gave market has become quite crowded with all the expansion throughout the mid Atlantic and Northeast. On a scale of I'll do this on a scale

of one to ten. If the if the court does not allow sports betting, how challenged is this market in the Northeast on a scale of one to tend and being it's really challenge. It's a challenging market compared to any prior time period. You've now got twelve casinos with ten more to come in Pennsylvania. Uh, You've got six casinos in Maryland. You've got more casinos in the New York States. So it's a crowded market. I think sports betting would certainly give some incremental tourism to places like

Pennsylvania Atlantic City. But Atlantic City is now just one of several destinations in the Mid Atlantic, which is why about half the casinos they have already shut down. Now we we we'll see what happens next. But I do think the Supreme Court is likely to allow for sports betting. I do think that's beneficial to Atlantic City. But I certainly think Eldorado Resorts has its eyes open in terms

of the historical challenges there. All right, I can't let you go with that giving giving us the lowdown on Wind Resorts and what's happening with the Steve Win Empire. So Win Resorts, which by the way, did pre announce at least January febru results they're having a good quarter, doesn't detract from the fact that company has a number

of challenges. A lot of the recent drama has centered around the fate of their property in Boston Win Boston Harbor, which could be renamed it could be sold to another operator. There were speculation last week that either MGM Resorts or another company might try to take over that license. Uh

and so, because of the ongoing questions. Even with Steve when having sold his stock, resigned the CEO UH and Nonger being either an officer or board member, they're still ongoing scrutiny of the suitability of the other officers and directors as it relates to that Massachusetts gaming license. I have a feeling you're gonna be very busy and you're gonna keep us at the date on all of this. Thank you very much. Brian Edgar are expert, really whenever

it comes to gaming and lodging. Senior Gaming and Lodging analyst for Bloomberg Intelligence. Remember to follow him on Twitter at breaking Call at Agronomics. Now believe it or not, that's breaking news. Yes, anomics. We thought that sounded better, so and it does. And I'm going to follow you right now as a result of that. And is the stock market overvalued or undervalued? Let's find out. Let's ask

Jack Ablin. He is the founding partner in chief investment officer for Crescent Wealth Advisers based in Chicago, and you can follow Jack on Twitter at Jack Ablin. That's a B L I n R I Jack Ablin. Overvalued or undervalued? Make the case actually near term it's it's undervalued. If you look at one of the route force measures that I like to use, it's just a total return of the stock market against the cumulative growth of dividends and earnings UM. It shows that the market is probably about

five to seven percent undervalued. If you assume that the earnings were expecting for the next four quarters and the dividends were expecting for the next four quarters will will play out UM. So near term, I think that's a that's a good thing because we did start the year about eighteen percent overvalued, and I think between the market coming down and earnings expectations coming up UM, things have kind of settled out in your term. Long term that's

a different matter. You know, if you look at the Shiller's Index relative earnings over the last ten years, or if you look at a price to sales ratio UM, that would suggest negative returns for the next annually for the next three years. What is competing for investors money? Is it bonds? Because I'm looking at the twelvemonth dividend yield on the SMP five, we're just under two percent. Let's one point nine four percent, but let's call it just under two percent. Heck, you can do that in

a one year treasury, Yeah, that's it. UM. You can in fact that you know, two years starting to get pretty compelling as a quote unquote money market alternative UM. But UM interest rates longer terms still seem to be below where they ought to be long term. So if you look at the tenure treasury at two point eight and change, historically, that ten year tends to track nominal GDP UH. And last time we calculated nominal GDP at the end of the last year, UH, that number was

about four point one. So clearly we have another hundred basis points or so to move to the upside um to get to what it will call kind of long term fair value UM. And I think that can unfortunately constrains the Fed UH quite honestly, because what we find is that that tenure treasury isn't really tethered to FED policy. It's probably more closely linked to what's going on in Europe and Japan, and they're still pedal to the metal. Well but chack, let's let me, let's just make the case. Right.

Someone comes along and says, you know, I understand what you're saying. This all makes perfect sense. But you know, if I can get more than two in a treasury and not pay state and local taxes on it. Uh. Then and that's money good. Then you tell of me, well, you know, maybe I'm going to get a pop when it comes to the stock market. What kind of returns are you looking for in stocks in order to make

that more appealing? Yeah? I think that it's a good question because near term, you know, we can maybe get single digit uh gains um if you and and that's cumulative um for the next twelve months. So nothing really exciting here at home. Um. I don't think necessarily the bottom is going to fall out unless, of course, all of the data supporting the stock market falls by the wayside. But the economy appears to be pretty strong, So yeah, I don't think that the stock market is certainly a

table pounding near term by um. But um, you know, I think bonds still have to get a little more interesting, uh yield wise relative to longer term benchmarks to to you know, uh, really prompt us to shift out of equities and into more of a bond focus. All right, So there specific industry groups that you would be looking

to for greater capital appreciation. Yeah, I think that in this environment where we're taking what is a you know, call it a two percent donkey and beating it into a three percent or four percent racehorse, depending on how much we can accomplish with tax the tax reform, plus some infrastructure, maybe something else. Then I think that the they value oriented sectors, the industrial, financials, basic materials, Darius, even energy UM could take more of a leadership role

versus tech UM. I think the first quarter, what we're trying to do is adjust to the new tax regime UM and UM. You know, there are some bigger beneficiaries. Their financials certainly a huge beneficiary UM, but also technology probably benefiting from both says and maybe the increased investment. But I think once we kind of play out the first quarter results and look beyond here to the rest of the year, then I think UM investors are gonna want to look at the the economic environment, and I

think the value oriented sectors will tend to lead the mark. Okay, but all right, so and and Jack, you know I always challenge you on this. Let's say someone comes to you and says, boy, you know I have Netflix bought Netflix because my family spends all their time glued to Netflix. I'm paying the monthly subscription, the stock is up sixty year to date. Does Jack Ablin say take a little off the table and put some into energy industrials and financials?

What do you say, stay with what's working. If this is the kind of market that we're in and we're getting sixty year to date returns on a stock that is burning through cash, it's that kind of market. Yeah. And the funny thing about net Flex and I will say, you know, let's let's just you know, if we didn't have to take taxes in the consideration, which is I think keeping a lot of investors probably glued into some of the names that have been working over the last

couple of years. But if taxes weren't a consideration, I would say, yeah, let's take some of that off the table and let's diversified into into areas of the market that would benefit if we do get increased economic growth here at home. Remember the reason why, in many respects, the reason why investors love Netflix and they probably like Amazon for the same reason is that those are all

weather stocks. You know, Netflix is going to add subscribers and they're going to continue to push the bottom line no matter what goes on. Uh in the economic environment, no matter what kind of tweets that we hear or headlines. Whereas you know, it takes a lot of courage to buy say, uh, you know a Kroger or uh, you know something you know another the banks nowadays or some of the other industrial um that really do rely on improving economic conditions right. Uh. What what is the one

investment you would not touch right now, jack boy? And not touch? Probably I would say gold. Um. Gold is just not behaving the way uh the that um it has in the past. Historically it's been a great diversifier that zigged when everything else has zagged, and it just hasn't worked out this year. Um. And I think they're probably other alternatives perhaps um maybe even energy or maybe even master limited partnerships could serve that that purpose, uh

and do it in a way that gold can't. Remember, gold gets undermined, if you will, when rates go up because financial assets and real assets are are kind of competitive. We got to leave it there, Jack Avelin. He is founding partner chief investment officer Crescent Wealth Advisors. Follow him on Twitter. In a note to clients, Scott Minor, the head of investing for Googgenheim has said that there's a chance of a sharp procession and decline in stocks that

is looming. He says the worst of the damage would start in late into and he specifically called out corporate bond defaults. He said that increases are likely as the Federal Reserve raises interest rates and companies struggle to pay off record debt levels. Here to help us understand the role of corporate debt in this market is David Chain. He is the managing partner for Kennedy Lewis Investment Management and also joining me here in our eleven three oh

studio is a shri not Ragin. He is our Bloomberg debt reporter. Gentlemen, thanks very much for being with us. David, why don't you begin and give us your thoughts on the role that corporate debt is currently playing and it's size in the marketplace so that we can understand how important it really is. Absolutely, thank you very much. UM. Corporate debt markets today are larger than they've ever been historically. Total corporate debt today is of GDP. It's an all

time high. Uh so something that we obviously need to pay attention to. UM. Fiscal policy recent fiscal policy in terms of tax changes will continue to pressure the FED to raise rates. So we do see pressure as it relates to rising rates that will ultimately affect UM much of the corporate debt market today. When you look at the overall yields today, they're they're they're quite compressed relative

to historical standards. So we do see that as we look out in this specifically in the HYO market, we do see UM some of the maturity wall issues and you know early two thousand twenties, combined with tax changes that are are being implemented in terms of the interest deductibility for some of the more levered UH corporates out there,

we do see some real disruption coming. I think UM been from my perspective, when you see the likes of Guggenheim and Pimco and tc W send out warning flares, it's kind of important for us to sit up and take notice. These are big players in the corporate debt market, and effectively the tries are coming from inside the house, and that is why I think everyone's trying to figure out that. When Scott says maybe the next recession, which could be well months down the line eighteen months down

the line could be driven by corporate debt. That's reason to be wired about it. Because also remember that since the last recession, in the ten years that have elapsed, we have seen an explosion in the corporate credit market. And I think this is probably the time in the cycle. And maybe David could address this. Is you know where we see maybe with the smaller companies already issues are starting to pick up. Are we seeing a uptick in

Chapter eleven filings? And is that what sort of gives us a broader signal to what might come down the pike in a year or two from now. Yeah? Absolutely, Uh, we definitely see that. We're starting to see if you look at the rolling three months Chapter eleven filings over the last several months, you're starting to see an uptick,

especially as it relates to smaller companies. Um. I just note that when you look at the new issue market for high old in the last month or so, you've seen at least twelve to fifteen corporates where they've issued paper where paper is trading below a hundred cents on the dollar. Uh So the new issue market is starting to get a little shaky. Um. And then I think as it relates to UM sectors that are in secular decline UM, whether that be wireless UM, auto rental companies

and autos in general, you know, retail, hospitals, etcetera. Uh. There's a huge amount of debt in each of those sectors. So you've got a secular decline happening. At the same time, they're going to be trying to figure out how to refinance their structure and uh and and then again deal with some of these interest deductibility issues that I mentioned coming in their early two thousand twenties. Well, David, you you at Kennedy Lewis, you raised two hundred and fifty

million dollars in November. Right, that's for fund. That fund is destined for distressed debt. Right. Yes, we define ourselves as opportunistic credit managers, which includes a component includes distressed debt. That's right, Okay, And you've got five years to invest this money. So are you waiting? We are. We are waiting to a large degree. But two Uh, we we do have some sectors that we identified that we think

are very attractive. Now. UM. We are focused on the middle market space where there's less UM we think competition UH for players like ourselves that can deliver capital structure solutions. UM. So some of the sectors that we like and that we're focused on are the animal care sector as well. Uh. You know, the power markets in Texas. There's been a

real disruption in the power markets in Texas. We we think this supply demand and balance in Texas is coming into play and UM and so a lot of the high cost coal companies that are coming out of the market there, they just can't compete with natural gas where it is. So we do like UM some sectors there,

and we are putting dollars to work in. What kind of yield does it have to offer you in order to be attractive for for our fund in particular, we are targeting at one point five times money multiple over a five year period of time, which equates to roughly a mid teens yield. Uh. And we are finding those opportunities in those sectors. But help us understand one thing David wouldn't uh, and maybe this is the reason for it.

When we talk to the bigger distress films right now, all of them are complaining about how there's so little to do. Is that a reason why we're seeing sort of an uptick in almost manufactured events. You know, the CDs clash which involves Blackstone, a bunch of hatge funds, even Goldman that has gripped everyone in them Okay, Windstream and all the scenarios like that where people are making arcin legal arguments to win returns. Is that just a result of there's very little else to do, so you

have to make stuff for yourself right now? Yeah, I believe that's that's that's partially the case. Absolutely. I think you know a lot of the large uh cap credit players UM have found that, you know, they need to be focused on um what we call, you know, sort of binary outcomes on technicalities right with you know, focused on loopholes within legal documents. UM. You know, they're forced to put a lot more dollars to work in any

one particular situation. And there's not large scale distress okay, that's happening in the market today, so those opportunities are fewer and far between, and then therefore they're they're forced to focus on these the CDs issues that we've we've seen in names like Habnanian. Just to go back to your point earlier that the total amount of corporate debt

outstanding is greater than us g EP. That's that's correct, including investment grade and high Okay, if you get a big move in interest rates, that's gonna make a lot of that paper much less attractive, even if those debts are wonderful and the companies continue to pay. That's that's absolutely right. And we've seen that already this year with respect to investment grade returns as well as high yield returns,

they're both negative on the year. Okay. The reason I go there is because a lot of times you have to separate whether someone wants to be an investor and hold the paper versus whether there is an intrinsic problem with the company that has borrowed the money. In today's marketplace, you can have a bunch of people Russian for the exits and the company is still fine. That's right. That makes it must make it difficult for you. Well, I think I think in some ways we see that as

an opportunity. I mean, we have outflows in high yield UH year to date this this year that we haven't seen in man years. So you know, we do get a baby with the bathwater scenario and some and that's when you come in and We try and be an open tunistic We focus on the areas that we think we have core expertise, on the sectors that we think we're good at, and that's when we come in. Thanks very much, David Shane, Managing Partner, Kennedy Lewis Investment Management.

By thanks also to shreet not Rain. He is our Bloomberg debt reporter. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio