Bank Earnings: What We Know and What We Don't

Earnings season is now underway, and we've heard from the largest U.S. banks. In this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP take a look at earnings from JPMorgan Chase (JPM 2.51%), Bank of America (BAC 3.35%), and Wells Fargo (WFC 2.74%) and discuss what investors should watch going forward. Then, they answer listener questions and talk about two stocks -- a credit card giant and an insurer -- that are on their radar this week.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on April 20, 2020.

Jason Moser: It's Monday, April 20th. I'm your host, Jason Moser, and on today's Financials show, we're going to dig into what investors need to know from the latest big banks' earnings reports. We have a couple of listener questions to get to and, of course, we've always got a couple of radar stocks, a couple stocks that we're watching for you this coming week.

Joining me, as always, Certified Financial Planner Mr. Matt Frankel. Matt, how is everything going?

Matt Frankel: Pretty good. Well, the weather is not so great, but, meh, what can you do?

Moser: You know, it's a little bit overcast. You know what, it's a little bit cooler. I think people are ready for it to warm up. We've gone through a little bit of a cool spell up here in Virginia and it sounds like South Carolina is a lot of the same.

Frankel: Yeah, again, rain and cold.

Moser: Well, you know, at least, we get something to look forward to. At some point, it will be spring and it seems like spring, it almost doesn't even exist anymore. It's like we go from winter into summer, and, like, what happened to spring? And now there's no Masters tournaments, then we don't get Augusta. Killing me.

Frankel: March Madness. I mean, come on now.

Moser: Speaking of March Madness -- and by the way, I don't know if you've caught any of that Last Dance, Michael Jordan documentary last night, the Bulls documentary, but I watched the first episode of that last night, that was really good. But I saw an interesting tweet, I think it was from Kenny Smith on Twitter, former Tar Heel. And he suggested that at some point, you just need to gather all of the NBA teams and go in for a single elimination tournament, you know, do it somewhere confined where they can test everybody and it would be no fans, of course, but you would have it televised, and you run like a two-week tournament, where it's just a single elimination, kind of like a March Madness, except for the NBA. I thought that was a great idea. I'd watch every game of that, I think.

Frankel: Yeah, I mean, I was hearing something, where are they going to hold it? In Vegas, I think it was where they were talking about.

Moser: Yeah, that was what they were talking about.

Frankel: I mean, I was reading an article that the sports betters are getting so desperate they're betting on things like table tennis and -- [laughs]

Moser: [laughs] Oh, my God! We got to turn a corner here soon, man. Everybody is going crazy.

Frankel: I agree.

Moser: [laughs] Well, let's dive into what listeners are really here for, Matt, and that is we want to talk about financials. We want to talk about earnings season. Last week, we had a lot of big banks report earnings and we're going to focus our conversation today really on the big three: JPMorgan, Wells Fargo, and Bank of America. Because those earnings reports came out, there wasn't a lot in the way of surprises. I mean, we knew going into this earnings season, it was going to be bad. I tend to think that maybe next earnings season is going to be a little bit more important, because it's going to give us some context, we'll understand how bad things really are now or really were if they are improving next earning season.

But let's take a look at these banks and talk about these reports for a little bit, because one of the things I was thinking about going into this earnings season was that regardless of the numbers that they turned in, it seems to me at least that one of the byproducts of the Great Recession, it could be argued at least, is that put our major financial institutions on firmer footing from a capital perspective. I think, maybe it gave them the opportunity to be a little bit more prepared for future challenges like we're running into now. But sum this earning season up for so far, to put it in the context of these three banks, sum this earnings season up for so far.

Frankel: Well, as far as just earnings and the business themselves, most of these look actually fairly decent. You got to remember January and February were pretty normal months. And, I mean, the first part of March was for the most part too. The first part of March, I mean, we were still traveling, it was business as usual in most parts of the country for the first week or two.

It wasn't until, I want to say, South Carolina did our big shutdown on March 16th, I was working in my office up until then. So, you got to remember there was just a little bit of the actual effects of this that were reflected in the earnings. The big issue that really scared investors, banks were some of the worst-performing stocks last week. The market did actually fairly well last week, but bank stocks just took a nosedive.

Moser: But when we look at the interest rate environment, that's not that surprising, right? I mean, it's kind of one-two punch there?

Frankel: No. Earnings dropped a little bit. The interest rate environment is awful for these banks. We're going to see that really baked in and starting the second quarter. Because, again, remember January, February, pretty normal when it came to interest rates, so it's really just the March numbers we're seeing reflected. But the real thing that scared investors, like the reason that stocks tanked, is because all of these loan reserves.

Moser: That was -- yeah, you said it. "Reserves," that was the word that I took away from this season, [laughs] that was the word it seemed like it was most commonly used in the earnings calls.

Frankel: Right. Here, take JPMorgan, for example, they generally in a quarter set aside somewhere like $1.5 billion for loan losses. These banks have massive loan portfolios, inevitably some people aren't going to be able to make their payments, some loans are going to get charged off, so banks set aside reserves to deal with this.

This quarter JPMorgan increased their loan reserves by $6.8 billion as compared to the first quarter of last year. That's a huge number. That means this is telling people that the banks are expecting a big wave of loan defaults; again, we haven't seen them yet. I mean, especially, the first quarter ended March 31st, no one was having trouble paying their bills by then, I think it's fair to say. You know, loan bills are due once a month, everyone was -- not everybody, but for the most part it wasn't really reflected in the March numbers. So, you're going to see going forward.

And the question is how much help are the people going to get from the government with stimulus payments, the enhanced unemployment benefits under the CARES Act, things like that? How much is that going to help people keep their financial obligations going? And how much will we see this suffer? Because, you got to remember that Chase has a giant credit card portfolio -- that's a very susceptible thing to recessions. So, if this is a deep recession, these banks could see loan losses just skyrocket like we did in the financial crisis. Hopefully, it won't be the case, and that this is kind of an overpreparation for that.

Moser: Yeah, and that's what I was thinking -- I'm glad that we brought up the reserves, because I went through, I saw that number in the JPMorgan calls, looking through Bank of America, they built their reserves up by $3.6 billion, and actually now, since year-end, they've built their reserves up close to $7 billion. And Wells Fargo was obviously very much the same. Wells is in a little bit of a different position because they're trying to manage themselves through some restrictions on the Fed side.

So, one of the things, I like to look for language in these earnings calls because it gives me an idea of what really the point of focus is. And so, I went through JPMorgan's earnings call this quarter versus the same quarter a year ago, and that word "reserve" was mentioned 33X this quarter in JPMorgan's call. Now that compares to just 9X a year ago.

Frankel: Yes, the reserves are definitely weighing on people's minds, and it's interesting you brought up the Wells Fargo restriction, because they actually got it removed for the purpose of making these small-business loans.

Moser: And, yeah, that was another thing I was going to mention, was it seemed like it actually could have been a little bit of a tailwind for them, perhaps.

Frankel: Yeah, and Wells Fargo, it's kind of interesting to mention, was the bank out of those three that got really crushed last week. And there's a good reason for it. And JPMorgan and Bank of America both have big investment banking operations. So, while the heart of their business, the other consumer banking stuff is getting crushed, a silver lining is that trading revenue and stuff like that tends to pick up in volatile times. So, not only did the trading revenue look great in the first quarter, because of just the March market downturn created a lot of volume, you're going to see this kind of reflected throughout the year.

Wells Fargo, on the other hand, does not have investment banking. They're pretty much like a normal savings and loan.

Moser: Yeah, their big cash cow is mortgage banking. I mean, that's where they make a lot of their money, on that mortgage side.

Frankel: Yeah, they have mortgage banking and they have a big auto lending operation. My auto loan is under Wells Fargo, for example. Wells Fargo, I think they're No. 2, it's between them and Ally Financial, they're the No. 1 and No. 2 in the country for auto loans. So, they have a big auto lending operation, which obviously, [laughs] that's not a great business to be in right now. Who's buying cars at the moment? Not many people.

And the auto manufacturers are so desperate for business, they're offering excellent financial terms themselves. Which I think is taking whatever business is there away from the banks. I saw GM, for example, doing 84 months, 0% financing.

Moser: Well, yeah. You know, I have a Ford Explorer that I got five years ago or something. When I got that five years ago, even the Ford dealership at the time it was 0% financing, if you have the credit score to qualify. So, I mean, they really haven't been able to witness any long stretch where they could start boosting up that lending side of the business very much on the auto side. I mean, you got to figure it's probably going to go on for a little while from here on out, too.

Frankel: Yeah, it's an interesting time, and Wells Fargo is really going to bear the brunt of it in terms of the big three banks, just because they are just a consumer bank, they don't have the benefit of, you know, good investment banks. And all these companies raising debt, that's a big part of investment banking is debt offerings.

Moser: That's a good point.

Frankel: So, I mean, JPMorgan and Bank of America are getting that tailwind too. So, Wells Fargo is getting crushed and it could -- I mean, Warren Buffett said a while ago that Wells Fargo, he thought, was going to be the best performer over the next 10 years. And if you believe him, [laughs] now could be a good time to take a look.

Moser: Yeah, well, I mean, given their presence in the mortgage space, that's plausible at least. I certainly wouldn't dismiss Wells Fargo, particularly, if [Charles] (sic) Scharf really is able to change the culture there, to really swing the culture back from the problems that they witnessed just in these last few years.

You know, going back to that reserves data just for a minute, because I thought this was just -- I just enjoy doing this, I guess, for whatever reason. But that word "reserve" in Bank of America's call this quarter was mentioned 48X versus 11X a year ago. And so, I guess my point is that just that was really the common theme, that was the common thread in all of these calls. And that kind of goes back to my initial statement when we opened the show, it does feel like these banks are in a little bit of a better position maybe mentally, certainly from a balance sheet perspective. I think they came into this period of time with a little bit of a better sense of being prepared for really, really bad case scenarios. It sounds like they're all well capitalized, it sounds like they're also spending their share buybacks for now, it sounds like they are going to continue paying the dividends but the dividends are going to stay on the radar, they're going to make sure that they can afford them, and if they need to cut the dividend or perhaps halt the dividend for a stretch of time, that's not off the table either.

But you know, I walked out of this -- granted, I do think we're going to learn a lot more next earnings season, but I do feel like, at least, just from a balance sheet perspective, from a mentality perspective, I feel like these banks are in a better position now, and maybe that is thanks to what we went through back in 2007, '08, and '09.

Frankel: Oh, sure, these are not the same financial institutions that you had in 2007, I mean, the worst-case scenario, the stress tests that they're put through every year, the worst-case scenario is a lot worse than anything we're facing right now. And this is just expected to be really a short-term recession, where the stress tests really look at like a deep prolonged recession which, I mean, even the most pessimistic people really aren't expecting this recession to last for a year, for example.

So, these banks are well capitalized to make it through, they've halted their buybacks, which remember, these were all approved for what, $10 billion to $20 billion buybacks each, approved by the government. So, they're in really good financial condition. I wouldn't be too worried about them making it through, but as far as profitability, that could be a concern.

Moser: Yeah. So, before we wrap this conversation up with these banks, I know we wanted to talk a little bit about just the lending standards and how these banks are approaching underwriting some of these loans. And JPMorgan we had read last week, or maybe it was late in the week before, but they're really tightening up their lending standards and focus more on maintaining the lending base that they have as opposed to bringing new loans in right now. I mean, this is a point in time where they're becoming a little bit more strict on their lending standards, on their underwriting standards, aren't they?

Frankel: Yeah. I mean, JPMorgan was the first to act so far, they did two big moves last week. One, they tightened up their mortgage standards for new customers, have to have a 700 FICO score and 20% down for a mortgage with JPMorgan, which makes sense. I mean, they're not cutting off new business, but they want the top-notch customers coming in. We saw something very similar during the financial crisis where it was just tough to get a mortgage for a while if you weren't a prime credit borrower. So, we're seeing stuff like that.

And just for reference, the normal minimum for a conventional mortgage is 620. So, 700 is significantly higher than is normally required.

And then the second thing they did, they cut off home equity line of credit applications to everybody. I mean, if you have an existing line of credit with JPMorgan, they're honoring that, but they're not taking any new business. And it makes sense, because a line of credit is a second lien on a house. If the borrower doesn't pay and the house is foreclosed upon them, first mortgage gets paid first. So, it's considered a riskier type of borrowing.

They're still processing refinances in large volumes, which are first lien mortgages. So, they're trying to kind of, de-risk their mortgage portfolio. I could definitely see other lenders, kind of, follow suit here. When you get into tough times, uncertainty is the enemy and they're really trying to get rid of any uncertainty in their loan portfolio right now.

Moser: Very understandable. Well, before we continue, a reminder for those of you looking for more stock ideas. Now is a great time to check out our Stock Advisor service where you get stock recommendations from David and Tom Gardner every month Best Buys Now and a whole lot more. And why is it a great time, because if you go to IF.Fool.com, you can take advantage of a special 50% discount for our Industry Focus listeners. That's right, you, our wonderful listeners, 50% off. You got to go check it out. So, go to IF.Fool.com, check out Stock Advisor and all the great stuff it has to offer. I'm certain you'll like it.

OK, Matt, let's jump into a couple of listener questions we've gotten here recently. And we got an email from Kim. And Kim says, "Hi, guys, I hope you're keeping safe, well and managing to stay sane. I have a question about StoneCo. I know it's not part of the War on Cash basket, but it's definitely in that space and it's looking very downtrodden right now, at only 28X P/E. It showed huge growth in the last earnings report, and on top of that, Warren Buffett owns a significant slice of it. I love the digital payment space, especially in emerging markets. Am I missing something here, because it looks like there are some great tailwinds here over the next 10 to 20 years?" And Kim goes on to say, "Also, I'm going to be cheeky and ask another question, if I may. You guys talk about looking at the balance sheet and especially so in the current environment. What are things I should be looking for? Obviously, how much cash and debt, but what is a good level? Are there any rules of thumb? Thank you so much for keeping the podcast going, it's honestly one of the highlights of my day as I live on my own. I absolutely love it, and the analysis is priceless."

Kim, thank you very much for those kind words, I can tell you, we're thrilled to be able to keep bringing you these podcasts and knowing that you're listening and getting a lot out of it, that means a lot to us. So, we want to tackle this question. And, Matt, let's go ahead and jump at StoneCo first here, because this is a company that you and I both looked at before.

Yeah, I mean StoneCo is having a tough year, down around 40%, and it's understandable, I guess, from the perspective this is really all Brazil, that's their market. And the coronavirus is shutting everything down. Brazil is one of the more affected countries in Latin America right now due to the coronavirus. What's your take on StoneCo at this point?

Frankel: Well, it's down for a reason. I mean, we've seen kind of a similar downswing in Square, which I call Square, the kind of, I guess, closest parallel in the U.S. market to StoneCo in terms of what they do, like, just payment processing for businesses.

So, in Brazil you have businesses shut down, but they don't really have the same financial help that they're getting here in terms of, like, the forgivable loans to businesses under the Paycheck Protection Program and things like that. So, it's down for a reason. And plus, Brazil, I'd say, I mean I'm not -- our coronavirus response hasn't been perfect, but Brazil is also not in a great as good of a position as some other countries to fight the disease.

It does have some great long-term tailwinds, but it's down for a reason in the meantime. It's going to be quite a rollercoaster ride until this pandemic goes away. I would add it to the basket, but I'd take a nibble rather than a big bite.

Moser: Yeah, I agree with you, I look at StoneCo and I think it's one worth considering in the context of a basket, but if I was looking to make investments in the payments space I don't know that I would be looking at StoneCo as some big, sort of, a bedrock holding in my portfolio in regard. Because, again, I mean it is a limited market at this point; I mean, it really is Brazil that's where they make their money. And it's not to say that they can't or won't expand their market, but you have to at least acknowledge the fact that for right now, they are dealing with one specific market that is certainly going through its own set of challenges.

But to Kim's point they did release some very good metrics here at the beginning of March when they released earnings. I mean, total payment volume growth was close to 52%. So, clearly people are using the platform and more money is going through it. What do you think about the balance sheet question there, Matt? What do you look for when you try to assess a company's balance sheet to say, is this healthy or should I be concerned?

Frankel: In the context of the current pandemic, it's, kind of, where I assume that question is coming from, I look for liquidity. It's not just the balance sheet, it's the ability to borrow as well. You know I look at a lot of real estate stocks, so it's a lot easier in real estate than it is with banks. But, for example, if a company has, say, $300 million in cash on its balance sheet and it has a credit line of $1 billion, then it has $1.3 billion of total liquidity and that's what I look at when it comes to making it through tough a time like this.

I look at liquidity, debt. Obviously, you want a company with no debt. StoneCo, I'm not really familiar with their balance sheet, I'd love to answer that a little more specifically with them. But I look at how much money is on their balance sheet, how much debt and how much they can borrow is kind of the big thing that I think people will overlook in a situation like this.

Moser: Yeah, I mean, I agree it's nice to find companies with no debt. You know, I think that if they do have debt, you just want to make sure they can manage that debt, you look through that coverage ratio to make sure that the operating earnings can cover the interest expense on an annual basis. And typically, with payments companies, they're a bit more of a recurring revenue stream, so they're a little bit more protected. It looks like in StoneCo's case, I mean, there's very, very modest debt on the balance sheet, net debt position $500 million or so. So, I wouldn't put them in a class of companies we should be concerned about in regard to the balance sheet. I think, more, it's a question of the market that they serve and how long this downtime is going to last. But we shall see, I guess.

We had another question here, Matt, and this came to me on Twitter the other day. It's a question from Vivaan Bala. And he says, "Hi, Jason, I hope you're doing well. I had some questions about making it big during a financial crisis like this. I've heard a lot of people say that people become rich during times like these. And this was also the case during the Financial Crisis of 2008, can you help me with what I should be doing as of now to get on top of this game and leave my 9-to-5 life behind forever?"

And, Matt, I wanted to bring this question over because there are a lot of good things to take away from this question here. And the thing that stood out to me, the item that stood out to me was leaving that 9-to-5 life behind forever. But let's address this for a second, because I think Vivaan brings up a couple of questions a lot of people are probably wondering. And, you know, we had the experience, we had the good fortune, honestly, to go through that Great Recession a little bit more than a decade ago and experience that and we've been investing for a while.

And you know, I feel like maybe, based on what he's hearing from other people, that might be an oversimplification, like, this is where you become rich during times like these. These are definitely times of opportunity, but I also don't want it to sound like this is where you get rich quick, so that you can then quit work and just go live your life playing golf and sitting by the pool, drinking Mai Tais.

Frankel: Yeah, if anyone listening has figured out how to make enough money to do that, then let me know. [laughs] Because I certainly haven't. But, no, the thing I would tell people is that this is a great time -- people do become rich because of crises like this and the financial crisis. I mean, let's not lose sight. There is real suffering going on. This is not a pleasant situation for anybody, so I don't want to glorify it.

But the reason people become rich off things like this is buying great companies at low prices and holding onto them for years and years and years.

Moser: Right. And that's it: It's not getting rich overnight. This is where you lay down the groundwork.

Frankel: Right. I mean, when I bought shares of Bank of America in the financial crisis, I didn't become rich instantly off of it, but it's become a pretty nice gain in my portfolio over the past 10 years or so. So, it's not about getting rich quick -- it's about getting rich slowly. And this is a good opportunity to do that. But if you're looking to quit your 9-to-5 by buying stocks, I wish you luck.

Moser: Yeah. Well, and that's it. I mean, I think for me, I look at anything, you know what, let's not begrudge the 9-to-5 life. The 9-to-5 life, that's going to let you support yourself and live your life and grow and save and invest. You want that 9-to-5 life because that enables you to continue to invest, you get the money to continue investing like that.

And when you look at what happened during the Great Recession, we saw the S&P lost approximately 50% of its value at the lows there. And the Dow hit around 6,500 at the low points of the Great Recession. And we were close to 30,000 on the Dow here before the coronavirus impact. So, yeah, I think it's just that's it, it's like, this is where wealth is created, times like these are where wealth is created, but it's a matter of -- you need to understand that that wealth is going to be created over long periods of time.

This is where you buy into those awesome businesses, but that's only one part of the equation, the other part of the equation and perhaps the most important part of it, is time and that is where you have to be patient and understand that you're going to leave that 9-to-5 life behind forever at some point, but if you're young and able to work, I mean, you want to keep doing that. You lay the groundwork as an investor so that when you're ready to leave that 9-to-5 life behind, when you're 50 or 60 or whatever age, then you're going to have that portfolio that you've been investing in all along the way, and taking advantage of depressed times like these, when a lot of these great companies are on sale.

Frankel: Yeah, I would agree with that. I mean, it's a long game, this is a great long-term entry point, but I don't know what the market is going to do, it could go down from here if we get the wrong news with this virus, that's another thing that's interesting to point out. I mean it's entirely possible we retest the lows and you lose some money in the intermediate term. So, I'd caution playing the short game here.

Moser: Yeah, and I think you and I would both agree that if we do see the market retest lows, at some point here later on in the year, you and I, I think, would agree that would represent more opportunity to invest?

Frankel: Yeah, but again, for a long term...

Moser: For a long-term investment, exactly. That's what we are.

Frankel: I've bought more aggressively in the past few weeks than I have since the financial crisis. I don't expect any of them to do well in the short-term. If anything, I expect them to go down and up and down and up and be a real rollercoaster and cause me some more gray hair in the meantime. But I don't expect any of them to do well in the immediate term. I expect these are companies that are going to be well positioned after the pandemic is over to get back to business and be as strong as ever and make money over the next decade or two and they'll be the examples I use when we have another crisis to reference the right way to invest, is kind of my hope here, not that they're going to make me rich and let me retire next year.

Moser: There you go. Well, good question, Vivian, I hope we've been able to help shed a little bit of light on that for you. OK, Matt, we're going to wrap it up here, but before we do, let's just jump into ones to watch. What's the stock you're watching here this coming week?

Frankel: Well, I would say American Express (AXP 6.22%) is a stock I'm watching. They report earnings Friday, ticker is AXP. Credit card debt, I kind of alluded to this earlier, is a very recession-prone type of debt. As in, when people have trouble paying their bills, they tend to pay their mortgage and their auto loan and things that could potentially get repossessed if they don't pay, before they pay their credit card debt. Credit card delinquencies, even in good times, are higher than most other forms of debt for that reason.

So, when recessions hit, they tend to get hit more than anything. And we've seen the credit card stocks really take a nosedive. I like American Express because, one, they have a very, kind of, high quality portfolio of debt compared to some of their peers. The average American Express cardholder is a higher income person, for example, more likely to have a job that's not being disrupted right now. Just on average.

They also have a huge small-business clientele. Most businesses I know have an Amex. So, that's another part of the portfolio, there's a lot of uncertainty around it. I think the government assistance to small businesses is going to get expanded this week, I think that's going to end up being less of a concern, you know, businesses paying their debts then the market seems to think it is. I'm an eternal optimist, so take that with a grain of salt. But I've been an American Express shareholder for years and I don't plan on selling any, and that's one high on my watchlist to potentially add to during all this.

Moser: Good stuff. Well, I'm going to keep an eye on Travelers (TRV 1.74%) insurance, ticker is TRV. Travelers earnings come out Tuesday morning, the stock is down about 25% this year, basically flat now over the last five years. I'm going to be just interested to hear how they're viewing the business in the face of these current conditions. I mean, insurance companies, pretty easy business to understand.

But we look at a lot of these insurance companies and a lot of value is created from share buybacks along with dividends, and their share count is down 20% since 2014, they yield 3.1% on the dividend. So, I'd like to hear management's thinking on capital allocation in the coming year and how they're viewing the claims environment.

You know, that's a company where I actually used to work at Travelers and still have a bit of a fondness for the big umbrella, so that's the one I've got on my radar.

But I think that's going to do it for us this week, Matt. I appreciate you taking the time out of your busy schedule. Hope that weather shapes up for you down there in South Carolina soon.

Frankel: Yeah, I hope I get to come see you guys and enjoy your Virginia weather sometime soon, but who knows when that'll happen.

Moser: Yeah, we'll open up HQ eventually, hopefully sooner rather than later, but I guess that is still to be determined.

But remember, folks, you can always reach out to us on Twitter @MFIndustryFocus or drop us an email at [email protected].

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

Thanks, as always, to our man, Austin Morgan, for all his hard work behind Zoom. For Matt Frankel, I'm Jason Moser. Thanks for listening and we'll see you next week.