Surveillance: Bank Earnings With Michaud

Just walk us through the unprecedented environment we're working through right now with Wall Street's biggest names. Well, first of all, I've never seen a recession come this quickly in this hard so this is somewhat unprecedented. But I was just listening to your conversation just now, um, and you know there are going to be a couple of ways that that Wall Street is gonna interpret These are things, and you have to also understand I just saw them myself.

We were looking for a three point nine billion dollar provision came in much higher. The question is does JP Morgan see something that makes them terribly more cautious or in some ways you could think that the company is enormously well capitalized, has a great top line of earnings and in some ways just go big, take a big provision, And in some ways there's going to be some folks to just use a non financial term. Are you ripping

the band aid? Building a fortress balance sheet? This is your first quarter to do that since the virus arrived? And and was it was it more precautionary or was it in reaction to something that they believe is going to happen? And I think that's going to be what the streets looking for when we hear their eight thirty conference call today. So Tom, let's explore that further. I don't think anyone can tell us when we're going to reopen. Nobody can tell us when we're going to normalize. We

can game out a series of things, though. We can work out what any individual company is preparing for. Are they preparing for a one months shutdown, a two months shutdown? As you look at the numbers this morning, Tom, what is that a bank preparing for? What kind of preparation are they taking for a duation that lost the quarter,

two quarters slowdown that goes beyond that. So we were looking for a loan loss provision of four billion dollars in this quarter, and then and then increasing to something more like maybe let's say twelve billion dollars in the second quarter. So the question is how much of that first half low loss provisioning happened in the first quarter

instead of in the second quarter. And I'll give you another dimension that's not actually embedded in this press release but should be talked about, which is what are the credit losses that are expected over the cycle. If we're going to do the global financial crisis again, then that would be a very high single digit like let's say you'd have eight percent of the loan portfolio would be would be charged off over a period of several years.

We have been modeling something sort of maybe four percent for this cycle. If it turns out to be something more extended, then that I think that will change the dynamic a little bit because everything that we've modeled with more like a four percent, even up to a six percent is something that could be well handled by the capital base and the earnings power of the banks. And

and so I think that's the framework. Because this new accounting provision, which is called CECIL, requires the banks to provide for their expected credit losses over the life of the loan that is very different than prior crisis where banks met the losses more real time, and so that's what the market has to understand. That's why I was thinking my earlier comment that is this kind of a go big moment for JP. Morgan ripped the band aid,

take a bigger provision. Let's get out ahead of this because we're financially strong and we can or do they see something that's changed their opinion about the credit cycle over its entirety that we need to hear about. That's what I'm looking for, and we'll get more color hopefully on that at eight thirty Wall Street time when they

do have their press conference. Tom. I'm wondering going forward whether you see this as a position of strength for the banks to act counter cyclically, as John was saying, and the idea with Betsy Gray sick of Morgan Stanley saying, they actually stand to benefit on the other side of this because they have these fortress balance sheets. Do you agree? I do? I mean, I I'll pick on City Group for a second, and I checked last night. At the end of two thousand and seven, City Group had two

point six percent tangible common equity ratio. Today that numbers around seven and a half percent. So that's that's north, the two times that's north, the three times the capital base at the core of the balance sheet plus liquidity is far stronger. So I think this cycle, you know, it's gonna it's gonna to be tested. But but the banks are in a much better position to take charges and move forward. So but again, that doesn't mean if we get if we get a credit lost cycle like

the global financial crisis, then things could change. John farre and Lisa Brown with with Thomas showed to Stephile KBW. My name is Tom Keane. I just wandered in off the question I got delayed. I was down Madison Avenues at JP Morgan setting up a Christmas Club account. I got a toaster at the end of December. If Christmas club account, Thomas showed, you know, you just alluded to the power of Fortress Diamond or Fortress balance sheet and

all that. I get it. How many other banks, though, are like JP Morgan And the answer is not many. Is this going to be a big deal across five dred banks or six hundred banks, this new accounting provision given the pandemic shock that they're really gonna have the financial or balance sheet power that JP Morgan enjoys. Um, Look, I think JP Morgan is it's good that they go first generally, even though I think First Republic did just report also, but even though it's good done, they're a

smaller regional bank but still in the SP five. But um, I think it's good that JP Morgan goes first because, like you said, they are a best in class balance sheet as well as profitability. I think that there are other banks that have about the same capital ratios as JP Morgan, I'd say, in the same league. What other banks don't have, tom is the pre tax pre provision earnings power, and that is what's really it's we call

it the earning shield. So if you've got good levels of profitability, you know you typically it drives returns for your shareholders, but it also protects you in a downswing. JP Morgan has that, whereas there are other banks that just aren't as offittable is JP Morgan. And that's where the gap is wider, at least of the CFA definition for what Mr Michelle was just describing is called minting money. Yeah, well,

minting money and and and consolidating money. And that's actually where I wanted to go because there is this feeling that the biggest banks will get bigger in this crisis, in this downturn, because they do have the wherewithal to withstand this and even benefit on the other side. Tom, how much do you see that happening. Oh, it's going to come because well, well I'm not a believer that the world's going to be turned upside down on the

back side of this. But you know, one of the things we don't hear is complaints about people not able to move funds or because of all the digital access. So what this is. I think the studies that are going to be most interesting to read afterwards is what did bank customers do when they couldn't get to the bank.

The reality is that they did what they did before the crisis, They used more digital and so banks that have the digital capabilities I think are going to really prove that they stood up really well for their clients. And I think banks that didn't have it are going to re examine it, and I think that could help

cause fuel for consolidation. The other thing is on the back end of this, I expect that we're going to have near zero interest rates for a while and if you're a bank that is entirely spread dependent, meaning you don't have other businesses, it's going to put huge pressure on your earnings, and I think it could be a driver for consolidation. So I would expect there to be

more consolidation on the back side of this. And I wanted to get to another top point Tom you mentioned earlier, which is not all banks will will perform equally here. There will be some banks that will underperform and will have bigger issues than others. So most of the time when I'm talking, I'm talking about broadly, but there will be a couple, I'm sure a couple of banks that have a harder time during this cycle. It's great to get views, especially in earning seas. It's Almo b w

the c E wanking on JP Maulkin numbers. Laurie Kelvasin is in the trenches on this. She's at RBC does some wonderful work on the equity markets. Laurie to me, everybody's trying to get a bearing. They're trying to, you know, get to use the sailing illusion to get the keel set, get the sails set and move forward. How are you doing that? What are you using to establish a bearing forward? So you know, what I've told my team is that we are just going to keep moving the ball forward.

We're going to keep running the numbers, and we're going to adjust as needed. But we're trying not to get too caught up in the headlines of the day. Um. We're really trying to think longer term to the extent that we can, and we're just trying to process new

information as it comes in. Now. I've been very focused on things like my earnings model, not because I think I'm going to get it perfect right now, but because it helps me digesting in for nation as I come in to really understand, you know, what I know about this reporting season. I really need to understand what the hits are going to be to margins. That's something I

have trouble modeling. If I don't go through the process and try to get my numbers as good as I can, I won't have that information that thought process ready to go as I'm trying to digest this info. So Lori, as you look at the new information as it comes in this morning, it's from JP Morgan and Wells Fargo, and I'm wondering what the lone loss provisions and any color that we may get within ten minutes time from

Jamie Diamond of JP Morgan. How big of a hit are you sort of gleaning from the lone loss provisions, etcetera. Are you expecting to see sort of bleed out in main street going forward? Well, you know, we we One things we've talked about is the idea of collateral damage, and I think where the banks can be particularly helpful. To be honest, I'm not really so concerned about what

they're one Q numbers look like. I'm concerned about what their read is on the economy, how they're handling their customers, how they're stepping up to really support this economy going forward on. That's really the kind of thing I'm going to be listening for. The Other thing, frankly, I'm going to be listening for is what companies, especially on the financial services side, are doing with their dividends. What we've seen the past few weeks is that companies are defending

their dividends sacrificing their share buy backs. I need that dividend story to hold up to get retail investors back into the equity market. Well, long, let's talk about it. How vulnerable do you think those dividends are if this lockdown goes on for let's say, through May into June. So as we have looked back over the press releases, the eight k's, and the early reporters that have come in since March fifteenth, and we pick March fifteenth because that's the day a lot of the banks came in

and cut their their buy backs. Um, what we keep seeing is and is the idea that this crisis will be transitory. I haven't been counting how many times I've read the word transitory, but it keeps popping up, and we see that in the context of some of those

companies who have been defending their dividends. So my sense is that as long as this crisis is viewed as is something that's going to last a quarter or two, not really bleed into the second half of this year, not really bleed into next year, I think the company these are going to be comfortable trying to ride this out and keep those dividends intact. If it looks like this is going to be a longer bleed, then I

think we have to worry. So there's a new information on the earning side, which we're getting with progressive speed over this week and next. And then there's the positioning that John is referring to earlier in this idea that there does seem to be a capitulation with the Bank of America Fund Manager survey coming out and saying that there is extreme investor pessimism, the highest cash allocation, that

highest cash levels since nine eleven two and one. Do you think that that's enough to provide a floor to valuations or does this mean that perhaps people could get surprised on the downside. Yeah, so I think that when you're looking at any of these sentiment indicate there's whether it's their survey, my survey, or some of the weekly staffs that come out, you have to look at the preponderance of the evidence cash levels going from five point

one to five point nine. Frankly, that doesn't tell me all that much, and it flies in the face of everything that my clients have been telling me since this crisis began, which is that they have been looking for opportunities to upgrade their portfolio by names would have been on their shopping lift, and our trading desk has been busy. So you know, I hear that I don't know exactly

who they're talking to or who they're surveying. But I'll tell you it doesn't jive with what my conversations have been. It also doesn't jive with what my investor servey that I took at the end of March showed, which had fifty eight percent of those who responded were bulls, and that's the highest level of bullishness we've seen in three years. That's more instance with my conversations. Now, other things we've looked at our the CFTC data on US equity future

positioning and the a AII bears. Those did show that levels of bearishness and pessimism were achieved, but not the most extreme levels that we've seen in the past decade. So CFTC never got back to the lows on equity future positioning and a AII bears topped out of ground. It got back to seventy percent in the financial crisis.

So I will say at best, you know, I think that the sentiment picture is a bit mixed, but you know, my work just really doesn't jive with that via a survey, I got any other questions, laur Kelvicina, We don't know the time, but this has been brilliant. I'm gonna break the rule here. J Bryson is a wonderful economist with

a big broader view of course with Wells Fargo. But I'm gonna go narrow right now, Jay, and I'm gonna go forward to tomorrow, and arguably the first real look we have besides horrific claims at this new American economy, and that is a look at retail sales. Wells Fargo, with the heritage of John Sylvia, is wonderful at parsing

retail America. What do you see right now, Well, it's kind of a mixed bag, tom I mean, you know, on you know, we know that things like restaurants and hotels and things of that nature, all that very very weak um. On the other hand, Uh, there's gonna be a parcel offset, and I want to stress only parcel um.

You know, people serves to grocery stores and warehouses and things like that to stock up in in um in March, and so tomorrow's tomorrow will probably be a come on, somewhat of a mixed bagage should be a big negative number. But you know when when when we look at April, when those numbers print a month from now I think that's going to be even you know, weaker as well. Jay, there's also a question, I mean, looking past retail sales. The big number this week is Thursday, where we get

the next jobless claimed number. I am still absolutely dumb struck that nearly one in ten Americans has lost their job in the past three weeks. And I'm wondering what you're expecting in terms of Thursday's number and how quickly those jobs come back, given the fact that we are seeing destruction that cannot be replaced when it comes to going to restaurants, are going to hotels. Yeah, so last week it was the number of six point six million. I don't think we're gonna get quite that bad, although

it's gonna it'll be another in the millions. Um, you know, our guests here is when it's all said and done, you're gonna look, you're looking at somewhere north of twenty million people who who will will be losing their jobs, you know, and in you know, these these weeks, Um here, how fast does it come back? And that you know, it really depends on how quickly that the economy opens back up again. And that's really that's the virus's schedule, as Dr Fauci would would say, here and and and

so we'll see what happens there. You know, all these programs have been put into place by the federal government, by the Federal Reserve. It's acting as a bridge to get not all, but many businesses from where they were in February March to some time afterwards sometime late spring, early summer. And so some businesses you know who are still you know intact um maybe they're not. The restaurants that aren't aren't open right now, but they will come back.

And you know, I think there's going to be a pent up demand among people to go out and socialize and things of that nature. You know, that said, we're not going back to February come September. The unemployment rate is not going back to three point five um this year. Um. You know, our forecast goes out to the end of next year and we still have the unemployment rate north of six percent next year. You know, some of these

jobs that have been lost will be lost you know, forever. Um, not all of them, but um, you know, some of them will will be lost forever. Jay. For a lot of our audience, they hear repeatedly, all of these different forecasts coming from different places, including the IMF and yourself, a Wells farco. Can you help me understand the basic assumptions that underpin your forecast? What are the basic assumptions around when an economy like the United States starts to

reopen again? Right? Okay, So our assumptions are we assume that the economy is going to start to slowly reopen late spring, early summer. So let's call it, you know, sometimes the end of next month, um, you know, into into June. We also assume crucial me that um and let me let me back up. One of the reasons that we assume that is that we get you know, we flatten the curve, that we get control of this thing. If that doesn't happen, then the rest of the forecast

justus falls apart. But you know, so we assume it slowly starts to open up late spring, early summer, and then crucially, we're also assuming it doesn't come back in a quote meaningful way later this year. And again, if that's incorrect, then the rest of the forecast kind of kind of falls apart. And you know, John, Frankly, it's a lot of this is guesswork at this point, and educated guesswork, but it's guesswork. We we just don't have

a road map here. We've never seen anything like a sudden stop too, and not only the United States economy but to the global economy. So we're all kind of flying blind when it comes to forecasting. So J just sort of picking up on the I M F forecast. With the worst recession since the Great Depression, how is it that we do see another depression given the fact that that bounce back looks less and less likely the

longer this drags on. So I think my sense is talk about a Great Depression, I think that's a little bit overblown. I mean, the recession of nineteen twenty nine nineteen thirty turned into the Great Depression because of an

utter failure of policy. The Federal Reserve did not do its job as lender of last resort um, and so the banking system collapsed in the early nineteen thirties, credit dried up, and and you know, hundreds of thousands, of not billions, of businesses went out of business, and that's how you got the Great Depression. Plus the fact that fiscal policy didn't really turn stimulative until nineteen thirty four with you know, the some of the New Deal sort

of programs. This time around, policy has been very proactive, right The Federal Reserve has just opened up the tabs to keep all sorts of different financial markets liquefied. UH Fiscal policy has also turned very, very stimulated. The banking system today is much better capitalized than than it's certainly in my lifetime and probably back there in the Great

Depression or in the nineteen twenties. And so I think the way you potentially could get to a great depression is if this virus comes roaring back again in the fall, not only in the United States but in the rest of the world, and then all these measures we put in place up to now, Um, you guys got to do it all. Jay is a job at Amazon, A

real job, I mean is an economist. When you look at a hundred thousand jobs created, and I believe yesterday Basis and Company, so they're gonna go out and find another seventy five thousand warm bodies to do the Amazon thing. Are those quote unquote good jobs. Well, I'm not gonna opine on whether they're quote good jobs or not. I mean, I I don't know about how much they're getting paid

in the benefits and things of that nature. But you know, they are create they are creating income, They are creating a service for people. Um. And whether or not people decided to buy goods online via Amazon or at their local retailer. You know, in some sense, I don't really care. It's it's it's a job. It creates income, um, it

creates value in the economy. So um. You know, again, I don't know anything about the level of wages and benefits that those jobs pay, but yeah, they're they're they're certainly jobs with you always sposed to hear from me, ja ja. We always refer to as the acting chief economists. Can you tell your manager that if they aren't getting this done soon, we're just gonna start calling me the chief economists at Wells Falco Talent. They've got a month. Yeah, I'll say, I'll send the t on the tape of

this to him, John, I did. I looked at the Amazon job. I believe it's seventeen dollars an hour, which is thirty five dollars. You're sort of like a run, right, And these are the people that we now say are essential. So if we're gonna call them essential. Now. I think that after this fight, I need to come back and say, well, you guys think essential, let's start seeing some of that money.

Harry Chow and Durion with us who bmp Perry bout with truly decades of exposure, Harry, what is the symbolism of Western Canada hardesty closing under four dollars a barrel yesterday, right on the cusp of a record low. What is the symbolism of that in this conundrum of tanks up to the rim? I mean, what is that signal to a guy like you. Well, certainly signals that dropped in the US refinding activity, especially in the Mid Continent, dropped

in US refinding activity on a Gulf coast. These are really the hard lands of US refining, and it's just the broader reflection of a big decline and demand for oil products unless we end up with these prices of oil that are severely discounted to the benchmarks in the case of regional markets like Canada, Harry, I'm struggling to

understand the path forward. The idea that these production cuts that were agreed upon, you know, for put of enforcement and compliance to the side these cuts that were agreed upon, almost ten million barrels a day in production cuts. They're set to go into effect on May one. A lot of people say that they probably won't go into effect until June, just because of barrels that have already been

sold in the futures market for May. How much does this actually change the equation when it comes to much lower oil prices in the very near future. Well, I think that's a really valid point between the time of uh, you know, intending an agreeing production cut and the physical implementation of that. It's going to take some time. So even as these cuts are for effective made the first it's not going to be till later that we see

reductions happening. So this is why that gets the market, especially at the front of the curve, is being extremely cautious because we're not really addressing the demand decline through these cuts in the very short term. So it's only going to be, you know, by the end of the year that we're really going to see effect of these cuts, especially when we have a demand that has been locked down, unleashed with the progressive lifting of continent measures and other

social distancing. Harry, I'm looking right now was Texas prices at one dollar ninety two cents a barrel, plus or minus a few cents here there. I was looking at projections saying that of us shall companies will go bankrupt if prices don't get back up to three dollars a barrel or beyond in the near future. How likely is it that those projections are going to come to pass? Well,

I guess two things to consider there. A certain number of these companies are actually hedged for their production, but those that are not, probably the smaller players, will face difficulties. Typically the break even oil price in the Permian base and the drives US shales supply growth that break even prices closer to forty dollars, So I guess that's one of the aspects. The other thing, of course, is the banks that do fund a lot of these highly leveraged companies.

The question is what are they going to do? And I think that we're going to probably see, especially in these extraordinary times, is that banks will probably want to at least try to keep on board some of these companies restructured debt and and and try to wait till the end of the year when the oil prices rise let's explore this question a bit further, because I think

it's really important, Harry, what Lisa asked. We've been reflecting on cutting supply, cutting output in places like Sally Arabia, Russia, and nolsewhere we've not been thinking about taking out capacity. Even when this economy normalizes, these things won't pick up again. Your thoughts on that taking out supply versus taking out

actual capacity in the United States? M Well, I think the answer really interesting question because when you look at now the expectations for market driven declines in production and possible shut ins, there are two things to consider, conventional production and what would be short cycle non conventional US shale production. Because if you think of a place like Canada or Brazil, shutting down production is extremely costly, whereas uh in contrast, in the US, I guess that the

oil market is what economists would call more contestable. You could get in and out at a lower costs, you don't have as much sunk capital in it. So I would think that you know, if you do have shut ins and conventional production around the world, that may be more difficult to bring that capacity back in, whereas in the US just the very nature of US shale law, it could bounce back rapidly. Now, folks, a dumb surveillance question of the day. I'll ask it, Harry. When we

say people cheat, what do they actually do? I mean when great cheats? Are the United States cheats? When you hear that phrase, what's it mean in the oil world? But I think really the the optics of cheating are down to the fact that trying to measure that country's production and see whether or not that country has been reducing production in relation to a reference level or baseline level that has been decided during meetings such as the

Old Plus meetings. It's hard to say that the US cheats because in effect, you're not mandating a cut for US producers. The cuts will be market driven. So it's not a question of cheating here. It's a question of economics and whether or not, you know, companies are responding to those economics flashing caps for example, and so on. So the cheating aspect is really an issue of optics relative to measuring a country's production versus what it's I mean,

this is important. Lesa asked the brilliant question. John asked, almost as brilliant question. I'll follow up with the dumb question, which is which is just simple, what do you predict on a price per barrel of all this? We're twenty two dollars was Texas Intermediate? You said forty dollars? Is

where they click in what happens between twenty two and forty. Well, again we're back to which companies actually have had some of their production this year, and of course they would have hedged that at prices closer to fifty five or fifty dollars on a w t I basis, But there are going to be a number of small shale players that will suffer, and some of them will and he'd

have to close down. So in that respect, we will have both declients and production motivated by the fact that there's a lot less capex, so you're not going to be drilling to sustain your production as much. And then there's gonna be the the economics of the smaller companies that may force their their closure. So these are the two dynamics in the case of US shale. Hi Henry was quite scay thoughts on this program, Harry Child and go in that BMP paraplehead of Commodity Research, thanks for

listening to the Bloomberg Surveillance Podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keene before the podcast. You can always catch us worldwide. I'm Bloomberg Radio