Second-quarter earnings season unofficially kicks off Friday, with the first of the big banks getting on the board early. The results will be released amid increasing uncertainty in the U.S. economy. Banks are operating in a high-interest-rate environment (which can be good for profits) as the Federal Reserve mulls over further monetary tightening (which could increase the chances of a recession). At the same time, the financial sector has been recovering from the collapse of some regional lenders, which was precipitated by the March failure of Silicon Valley Bank (SVB). Wells Fargo (WFC) and Morgan Stanley (MS), our two financial holdings, will report quarterly numbers Friday and a week from Tuesday, respectively. Wall Street analysts, and the Club, will be watching a myriad of factors that could impact earnings. Banking backdrop The Fed released the results of its annual stress tests of banks’ capital buffers earlier this month. All 23 institutions tested, including Wells Fargo and Morgan Stanley, passed the exercise that simulates a hypothetical severe global recession. The stress tests, which started after the 2008 financial crisis, indicated that both firms have enough assets in their rainy day funds to weather an extreme economic downturn. Wells Fargo and Morgan Stanley announced increases in their capital returns to shareholders after clearing that regulatory hurdle. Morgan Stanley said it will increase its quarterly common stock dividend to 85 cents a share from 77.5 cents a share, along with reauthorizing a multiyear share repurchase program of up to $20 billion. Wells Fargo announced that it will raise its dividend to 35 cents a share from 30 cents a share. Meanwhile, banks are facing possible further regulation after the collapse of SVB and some other smaller financial firms earlier this year. New rules could require banks to hold as much as 20% more capital, The Wall Street Journal reported. Such a requirement could cut into revenue streams because banks may be more conservative with their lending. On top of that, funding costs for banks — interest rates paid to customers on deposits — have increased as the sector endures more outflows due to competition for funds from instruments such as bonds, money market funds, CDs, the likes of which banks have seen for years. This impacts certain banks differently, depending on the services they offer. Longtime bank analyst Christopher Whalen anticipates revenues for major banks to likely hold the line. Funding costs, however, may rise significantly. This dynamic would result in a compression of the net interest margin (NIM), which measures the difference between what banks pay on deposits and collect on loans, and therefore pressure net interest income (NII). “I think funding [costs] could double this quarter compared to last quarter, so a sequential doubling of interest expense. That’s mind-boggling,” the chairman of Whalen Global Advisor stold CNBC in an interview. “Banks are going to deal with it and others aren’t. I hate to say, but that’s the reality.” The banks that have “been really focused and have been willing to downsize and raise cash,” he added, will succeed in this macro environment. WFC YTD mountain Wells Fargo YTD performance Wells Fargo has a unique story among the major U.S. banks because of its multiyear restructuring plan. In 2021, the bank launched an initiative to improve its efficiency ratio — how much a bank’s non-interest expenses measure up to the revenue it generates. They’re aiming to realize $8 billion of gross cost savings over a roughly four-year time period, decreasing expenses by cutting branches, conducting layoffs and installing a new loan origination system. “While we expect NII to decline sequentially, WFC has pointed to a potential upside to its 10% growth target for the full year,” Barclays analysts wrote last month in a research note. “We expect an increased focus on costs looking out.” In the past, Wells Fargo has endured a slew of negative press over account scandals. The Fed levied an enforcement action in 2018 that limits Wells Fargo from managing assets worth more than $1.9 trillion. It’s unclear when the asset cap will be lifted. However, once it is (and we think it’s a when not if scenario), Wells Fargo will likely be able to generate more profits and increase its balance sheet. “They have finally cut their way through the army of zombies in terms of regulatory problems, which is time-consuming and expensive,” Whalen said, adding that Wells Fargo has likely the most upside potential out of the five major U.S. banks. MS YTD mountain Morgan Stanley YTD performance When Morgan Stanley reports, net assets in its wealth management (WM) business will be a key metric. Earlier this year, it was believed that larger banks like Morgan Stanley could benefit as many looked to move money out of smaller firms during the regional banking crisis. Investment banking (IB) has been taking hits, along with additional severance charges weighing on Morgan Stanley from a series of layoffs over the past year. “We expect a modest YoY [year over year] decline in revenues due to tough comps in trading and continued IB weakness while WM and IM [investment management] provide ballast. Deposit balances and their impact on NII will also be a focus. Still, we expect MS to reiterate its 20%+ long-term ROTCE target with continued progress on its $20bn share buyback plan,” according to Barclays analysts in June. ROTCE stands of return on average tangible common shareholders’ equity. More simply, a measurement of the bank’s ability to generate a return on its book — net assets on its balance sheet. Bottom line We want to hear how banks are thinking about looming capital requirement hikes. (If the rule is implemented, this could reduce further loan growth for both MS and WFC.) What do managements have to say about how a 20% increase may impact their individual books, along with the economy and banking sector more broadly? What about deposits? Have there been increased outflows over the last quarter? If so, have these stabilized? Is more money coming in from smaller firms to the majors following a crisis of confidence in the regional banking sector earlier this year? Wall Street still doesn’t have a clear picture of what the Fed’s rate hike campaign will look like in the future. After pausing in June, there’s a 92% chance central bankers will deliver another 25-basis-point hike at their next policy meeting later this month, according to the CME FedWatch Tool . We want to know how management may navigate a more competitive environment for cash and cash equivalents. Why should an investor leave their money in certain offerings with Wells Fargo or Morgan Stanley, for example, if yields for government bonds are rising higher? Overall, we’re using all this information to help shape our second-half outlook for the Club’s portfolio. (Jim Cramer’s Charitable Trust is long WFC and MS. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
A combination file photo shows Wells Fargo, Citibank, Morgan Stanley, JPMorgan Chase, Bank of America and Goldman Sachs.
Reuters
Second-quarter earnings season unofficially kicks off Friday, with the first of the big banks getting on the board early. The results will be released amid increasing uncertainty in the U.S. economy.
