What big bank earnings reveal about the health of U.S. financial system

JPMorgan Chase and Wells Fargo both reported quarterly reports that topped analyst estimates, while Citigroup was hit by a dealmaking drought. Crossmark Global Investments Chief Market Strategist Victoria Fernandez says banks so far are "off to a pretty decent start for this quarter." Hennessy Large Cap Financial Fund Manager David Ellison agrees, saying the banks benefitted not just from the rush to safety following the banking crisis, but also from higher rates. Both Fernandez and Ellison joined Yahoo Finance Live to discuss the results and they reveal about the health of the U.S. financial system.

Video Transcript

BRAD SMITH: The results from big banks kicking off a closely watched earnings season. The so-called big six will demonstrate if they recovered from one of the most challenging periods for the industry since the financial crisis. JPMorgan's results show it's still able to make lots of money from its loans and franchises but will smaller rivals hold up? And just how healthy is the financial sector?

A lot of big questions there. We're going to bring you in some big guests. David Ellison, Hennessy Large Cap Financial Fund portfolio manager, and Victoria Fernandez who is the Crossmark Global Investments Chief Market Strategist.

Thank you both for taking the time here with us this morning. We've got a lot to dig into especially on the back of these bank earnings. What is this tee up for the rest of earnings season from your perspective, Victoria?

VICTORIA FERNANDEZ: Well, I think when we're looking at this earning season, we have expectations that they were going to be down around 7%. That's what analysts were saying. And everyone looks at JPMorgan to say, all right, let's kick it off and get a feel for what we're going to get.

And if you look at the numbers we've seen so far, Brian was talking about a minute ago, you have Delta, PepsiCo, JPMorgan, Wells Fargo, they all did really well. Now we know the bar has been lowered, so the question that a lot of people had is, is just beating the number good enough right now? Well, based on what the stocks are doing, it seems like it is.

So does this hold up for the rest of the quarter? We don't know. Margins is something that we want to really pay attention to in regards to the pricing power of companies. When you look at the net interest income that you're seeing on these banks, it's telling you that they're doing well.

Loan growth was up at least in the big banks. We know we're going to see some differences when it comes to the regional banks. It's a very different story. Their balance sheets look very different. But for now, to kick it all off, it seems like we're off to a pretty decent start for this quarter.

JULIE HYMAN: Hey, David, let's get into the banks a little bit more. Your area of focus here. JPMorgan again just like hitting it out of the park and it just fascinating to me, the consistency. Yes, they got a lift from First Republic. What stands out to you from the quarter?

DAVID ELLISON: Well, I think the investment banking was a lot better than I thought it was going to be. But I think, generally, they benefited from the fact that they got covered, in a sense, by the government during the Silicon Valley problem where everybody said, well, they're going to be OK? So everybody rushed to the big banks. And they're benefiting from that and so is Wells Fargo and a little bit of Citigroup as well.

But I think, generally, people have been worried about credit since 2008. And Jamie Dimon is my age. I went through 2008 like he did. And I don't think we're going to have a credit problem. We're going to have a normalization of credit. And so the real story in this space is what's happened to the yield curve the last two, three years. And we're starting to see the benefits of higher rates for the banks.

And I think, historically, this is a great range for the banks to operate in. If they can make the loans at 6%, 8% and raise money at 3, 4, or 5, that's great for them. And we haven't had this rate structure in almost 20 years. So we're going to start to see that manifest itself in earnings and higher net interest income over the next year or so, maybe two years.

JULIE HYMAN: David, how concerned are you about expenses at the banks. That was a big area of focus going into these earnings reports. I see for JPMorgan, there was an 11% increase in non-interest expenses, in part, because of compensation.

Wells Fargo, the total there $13 billion. And we saw an increase in expenses over its city of 9% as well. Is that concerning level at all, or is it something that you think that investors need to pay attention to?

DAVID ELLISON: Well, certainly, I haven't had the chance to really dig into what's going on there, but I think, generally, they're still battling a lot of regulatory stuff. Obviously the Silicon Valley thing generated a lot of concern about what they were doing.

You know, they really haven't benefited from technology like other companies have. They've had a lot of competition, so they've had to keep expenses up meaning their competition from other non-depository. So I think, generally, that's-- to me, that's not the story.

Again, I'm going to come back to the fact that the yield curve has been historically ugly for these guys. That's bad for the banking industry. As that unwinds in the next couple of years, you're going to see big increases in earnings. And these big five-- these big seven banks, I think they're going to be great places to be long-term. You throw in a little M&A and you've got a pretty good view forward or a pretty good runway here in the next couple of years.

BRAD SMITH: Victoria, it's particularly interesting how the banks talk about the consumer right now and the state of the consumer. You've got JPMorgan basically saying that it's spending-- they're still spending, but a little bit more slowly. And then even if you look through some of the card metrics that these banks have put forward, Citi, they saw double digit cards growth.

So I wonder. Even if they're saying that the consumer is healthy right now, at what point does the consumer start to show signs of being unhealthy, especially if they're leaning more into some of the credit services or the card services that banks have, and they're changing the way that they spend even if they're not spending as much as they were before, they're just changing or tapping different areas of spending as their cash buffers run out?

Right. And we have seen that all through COVID, the shift in the way that consumers are spending. But we look at credit card debt. I mean, Julie was talking a minute ago. You've got JPMorgan, you've got Citi. These are the two biggest in credit card issuance.

You look at Capital One Financial that does a lot of credit card business, they actually came out this week and said they're seeing delinquencies go up some. So think you have to start watching what those delinquency rates look like. Right now, I don't think it's something to be concerned with. The consumer continues to be strong.

But here's what I think we need to pay attention to. We talk about the consumer slowing down. But if we see inflation continue to go on a downward trajectory and the wages and the labor market stay strong which is the situation that we're seeing, then real incomes actually are going to go higher. We could actually see more demand come out of consumers.

And then where does that spending go? Does it go back to goods? Are we going to see goods inflation start to rise again? It's very much a cycle that we have to work through. And because the labor market is continuing to hold on, you've got a consumer that's continuing to spend.

Even though we've seen saving rates come down, right? During COVID, what? Savings rates got up to around 35%. They're down now, back to around more historical averages around 5% or 6%, but still they have the ability to spend. And I think until we see the labor market really have some large cracks in it, until we really see those layoffs come in and people starting to struggle, then you're going to continue to see credit cards do well and the consumer spend.

JULIE HYMAN: David, as you look at the banks going into the second half of the year, is there anything that could derail what looks like some good forward momentum here? I mean, we are obviously going to see some fading effect from the First Republic boon that JPMorgan got, for example, is there anything else you're watching that is a risk?

DAVID ELLISON: Well, I think the risk is that the yield curve stays very inverted, and we get a big rally in the long end meaning rates fall and the short end doesn't fall because the Fed is not going to let that happen, let's say, for the next six or nine months, and then you're back into a squeeze on margins.

So I think-- the credit issue, I obviously think about it, but I'd rather have be making loans at 6%, 7%, 8% and have credit problems than to be making loans at 3% and have no credit problems, because it's a much better model for an active managed portfolio manager like myself, because I can hopefully pick the better managers that are going to make the better loans and be able to take advantage.

So I think the risk is still in my mind, the term structure of interest rates. That's been the problem. That was Silicon Valley. That's why JPMorgan got that great-- they made a great purchase, and they're seeing the benefit of that now. That was all the term structure of interest rates.

And so if the term structure of interest rates improves, I think the stocks all go up. If it stays where they are and gets worse, the stocks go down.