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Big banks are bearish on the economy, but bullish on their own ability to weather the current downturn, wrote analysts in a recent research note.
Those analysts, at BCA Research, think there’s truth — and an actionable investment thesis — in the big U.S. banks’ position. And given the recent carnage in the stock market — one closely-watched banking index BKX, -1.20% has lost nearly 40% in the year to date —suggests that banks are oversold.
In fact, the analysts at BCA recommend an overweight position, the equivalent of a buy, on stocks of the largest U.S. banks, even in the face of conditions they describe both “unprecedented” and “grim,” even understanding that it is a contrarian take.
There are a few pillars for their belief.
“We have long been of the view that post-financial crisis regulatory reforms left the (biggest) banks overcapitalized,” the BCA team wrote Monday. On earnings calls in mid-April, those institutions told analysts that they had sizable capital buffers, and that the “mix and quality” of the loans they’d made would keep them safe.
Bank lending grew at the slowest pace on record in the economic expansion that just ended, BCA noted, suggesting “banks committed fewer excesses in this cycle than they normally do.” Still, the analysts acknowledged, “the quality of the banks’ overall loan books won’t be known until the recession has run its course.”
For now, some of the most startling experiences of the past few weeks haven’t necessarily worked against the banks.
See also:This chart reflects the panic investors have felt amid recent turmoil
As previously reported, businesses drew down their credit lines at the sharpest pace on record in late March. As MarketWatch noted at the time, one of the biggest concerns many analysts had about that activity was that the coronavirus pandemic broke out at the same time that the global oil market was being upended. That raises the likelihood of defaults and bankruptcies.
But companies are stashing the cash they pulled out. Roughly 75% of those credit line draws were deposited with the bank, said Bank of America Corp. BAC, -3.35% CEO Brian Moynihan on his earnings call. About half the $40 billion increase in deposition in the month of March came from clients who drew on credit lines and then parked that cash “as they look to secure liquidity,” JPMorgan Chase & Co. JPM, -3.64% executives told analysts.
And bank chiefs uniformly said that the situation might not be as bad for their customers as the worst-case scenarios would suggest. “It wouldn’t surprise me to continue to have to add to reserves,” BCA quoted Wells Fargo & Co. WFC, -2.46% CEO Charles Scharf as saying, “but what we know is, we’re strong and the industry is strong to be able to handle this.”
And Michael Corbat, CEO of Citigroup C, -3.16% told analysts on a call to discuss quarterly results that the bank had entered the pandemic period “in a very strong position from a capital, liquidity, and balance sheet perspective. We have the resources we need to serve our clients without jeopardizing our safety and soundness.”
| Bank | Loan-loss reserves, in millions | Reserve ratio |
| Bank of America | 15,766 | 1.50% |
| Citigroup | 20,841 | 2.90% |
| JPMorgan | 23,244 | 2.30% |
| Wells Fargo | 11,263 | 1.10% |
| Source: BCA Research, company filings | ||
The table above shows selected metrics about how much banks are reserving. As MarketWatch’s Philip van Doorn reported recently, Citi set aside more than other banks, reflecting its greater international and credit-card exposure.
Meanwhile, Wells Fargo’s low level of reserves is a result of the 2018 restrictions it got from regulators, keeping it from expanding its balance sheet in the wake of ongoing customer scandals.
Of course, even if investors are inclined to believe bank executives on the subject of their business model, there is still the question of whether their stocks are appropriately valued.
In particular, BCA wrote, many Wall Street analysts are “clearly skeptical” that banks have set aside enough to cover those possible defaults and bankruptcies, an accounting metric also known as “loan losses.” And it is important to understand that the sustained nature of the economic lockdown means banks will likely need to continue to set aside money “aggressively,” they added.
That means the bottom line for anyone interested in understanding a bank’s value must have confidence in its earnings power, the BCA team explained. That metric, also sometimes called pretax net income, excluding provisions for loan losses, or “earnings power,” can be seen in the table below.
| Bank | Pretax, preprovision net revenue, in millions |
| Bank of America | 9,292 |
| Citigroup | 10,137 |
| JPMorgan | 11,401 |
| Wells Fargo | 4,669 |
| Source: BCA Research, company filings | |
“After seeing the first quarter results, and believing that monetary and fiscal policy will be able to reduce the overall level of credit losses and spread them out across several quarters, provided the shutdown doesn’t last more than six months, we subscribe to (a bull case.)”
See:Fool me twice? For businesses and consumers, coronavirus is the financial crisis all over again
