Bank stocks caught in ‘a conflicting period’ ahead of earnings season after bank failures: Analyst

RBC Capital Markets Managing Director Gerard Cassidy joins Yahoo Finance Live to discuss what impact the collapses of Signature Bank and Silicon Valley Bank will have on earnings season for the banking sector.

Video transcript

SEANA SMITH: The collapse of Silicon Valley Bank and Signature Bank sending shockwaves across the financial sector as many investors rushed to withdraw their deposits from some of the smaller players in the space.

But it wasn't just the regional-banking stocks that took a hit. The financial sector ETF XLF posted a loss during the first quarter, falling nearly 6%. So what are we going to learn this upcoming earnings season about the health of the banking system?

For that, we want to bring in our guest. Gerard Cassidy here joining us, RBC Capital Markets managing director. Gerard, it's great to see you. So just first, your takeaway on where the banking sector stands right now. The worst of it, is it behind us?

GERARD CASSIDY: Seana, I think so. When you take a look at what has happened, it's been quite an incredible period of time, particularly with, of course, Silicon Valley and Signature banks failing about three weeks ago.

And what's interesting is on Friday, the H.8 data came out, which measures the weekly loan trends and deposit trends for the banking industry. And everybody was very concerned, rightfully so, about the small-bank deposit trends, and they dropped meaningfully the week after the Silicon Valley and Signature Bank failures. But last week they were stable with the prior week, so that was an encouraging sign.

Now, that doesn't mean we're out of the woods yet. There are still some banks that still need to address some of these issues like a First Republic, for example. But for the most part, the regional banks, the models that banks use to run their business were extremely different than what Silicon Valley and Signature used. Both those banks relied on large corporate deposits for funding. Most American banks do not. Most-- or the big ones in particular, the regionals, have anywhere from 40% to 60% of their deposits from consumers, which are very sticky and are very low cost.

DAVE BRIGGS: When it comes to the big banks, Gerard, what do you think the impact will be in terms of lending conditions and, of course down the road, eventually on earnings?

GERARD CASSIDY: David, it's a good question because I think what we have to take a look at is what the economy is going to do. And the real GDPNow forecast, which came out on March 31, is still calling for, I think, 2.4% real GDP growth in the first quarter.

And there's certainly conflicting signs about what's going on in the economy, as we all know. If you take a look at the yield curves, they're all inverted, which would tell you that a recession is at our doorstep. The leading economic indicators are pointing to a recession.

But on the other hand, you look at the employment numbers. The employment numbers are still very strong. Wage growth is still strong. And so it's really a conflicting period here. But most importantly, loan growth in particular is tied to nominal GDP growth, and we are expecting, coming into this year, a slowdown in loan growth to about 3% to 5%. It may actually be a little slower now, 2% to 4% from what we saw in the second half of last year of double-digit loan growth.

So I think what you're going to hear from the banks when they start reporting numbers is that they probably are tightening up standards somewhat, just as a precaution. And we should expect to see slower loan growth as we go forward for the remainder of the year.

SEANA SMITH: Gerard, what about just credit quality? Do you expect that to remain strong? And also when it comes to some of the revenue growth there in terms of fees, fee-revenue growth, what do you think that's going to look like?

GERARD CASSIDY: It's a really good question, and I think you put your thumb on the critical issue for the banks, which is credit quality. And right now, you know, coming into the first quarter, it was very strong. Many of the banks were calling for more normalization of credit, as were we. I mean, the numbers are just too strong to be sustained, and part of the reason the numbers are so strong is all the money that was dispersed during the pandemic really enabled many borrowers, both consumers and corporates, to remain current on their loans.

And so I think what we're going to see is, over time, more normalization, which means net chargeoffs need to rise. Most of the models for earnings this year, ours included, include the expectation of higher credit costs, in some cases double from last year because last year's numbers were so good. So we anticipate that will be the case as we go forward.

On fees, it's going to be interesting because the investment-banking business, which is such a big part of the large banks' revenues, those numbers are still very depressed. Probably going to see those fees down 30% to 40% year over year, maybe even a little worse, led by advisory being the weakest.

But then on the trading front, I think you're going to see the FICC-- that's fixed income trading along with currencies and commodities-- those numbers are going to be good, and the equity-markets numbers shouldn't be too bad. So it's going to be a tale of two cities on the investment-banking revenue. Investment-banking fees down quite a bit, but trading revenues maybe up on a year-over-year basis but certainly not down as much as investment banking.

DAVE BRIGGS: Gerard, the numbers certainly in focus, but we always hang on the commentary of the big-bank CEOs, no one more so than, of course, Jamie Dimon. As a reminder, we started out Q4 with the prediction of just about every big-bank CEO of a mild recession ahead. What's your expectations for how they word what's coming down the road?

GERARD CASSIDY: It's an interesting observation because many of the banks were and are still planning for some type of recession, and the real question is, you know, the recent banking issues, will that turn a mild recession into something more severe? It doesn't seem to be the case yet because there was no real contagion from these problems. Once again, the Signature and Silicon Valley business models were very, very different that the industry as a whole, and the contagion problems with the help of the Treasury and the Fed and the FDIC taking the actions they took on that Sunday night, March 12, that kind of calmed fears and restored some confidence in the deposit side of the banking business.

But it's really going to come down to what the trends are for these banks, what they're seeing. And we'll get a read on that when they report their numbers because they'll be seeing the consumer trends. They'll be seeing the corporate commercial trends. And that will give them some guidance on whether this mild recession turns into something steeper, or does it remain a mild recession?

SEANA SMITH: We'll get those results starting next week. Gerard Cassidy, great to have you. Thank you.