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Deposits are banking industry's 'boogeyman': Money manager

Bank of America (BAC) and Morgan Stanley (MS) were the latest Big Bank stocks to report first-quarter earnings on Tuesday. Both topped earnings and revenue estimates, a trend consistent for major financial players who have reported earnings so far.

Hennessy Funds Portfolio Manager David Ellison joins Market Domination to discuss the biggest boons and challenges for the banking sector.

"I think the boogeyman or the real new issue is what's going to happen to the deposit side," Ellison explains. "Since the Silicon Valley-First Republic issues of a year or so ago, the deposit side has really been exposed as a risk factor for the industry that we've never had. So you see most of these large banks losing non-interest bearing deposits to the market..."

For more expert insight and the latest market action, click here to watch this full episode of Market Domination.

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This post was written by Luke Carberry Mogan.

Video transcript

[MUSIC PLAYING]

- More bank earnings coming in today with mixed results, we heard from Bank of America and Morgan Stanley. Our next guest says, there are still headwinds the industry has to wade through, and he favors bigger, more business-diverse banks. Here with us now to break down the latest bank earnings is David Ellison Portfolio Manager of the Hennessy Large and Small Cap Financial Funds. David, it is great to have you on the show. So maybe let's just dive right in, David, to some of these names. Morgan Stanley they reported investors seem pleased. Walk us through the results, David. What'd you make of them?

DAVID ELLISON: Well, the investment banking has been good across the industry, and they did another-- they had a good investment banking, sales, and trading quarter. Asset management continues to do reasonably well. Obviously, the market's been making new highs. And so the flows and the assets should follow that at Morgan Stanley. So I think it-- also one that's less sensitive to what's happening with traditional banking. Yield curve, credit, absolute level of rates don't impact them as much. So I think it becomes something to hang out in while you're waiting for the resolution on some of these other headwinds that aren't impacting Morgan Stanley.

- Yeah, I mean, we saw that really reflected in the other big banks that do have both sides of that business. Goldman doing better, more in the Morgan Stanley category. Then you have Bank of America reporting today the trading and asset management side of the business doing well, like it did at many of the banks. But higher credit card charge-offs, which reflects the more consumer challenges that are out there right now. How long are we in for that at the banks that delicate balancing act?

DAVID ELLISON: Yeah, well, I think the operative word they're using now is, credit is normalizing, which is, code for non-performers are rising, and they're rising pretty much across the board, not very fast at least for the ones that have already reported. And so I think that will continue just because that's what happens when the cycles start. It seems like, and yes, obviously, you got to watch it everybody's worried about commercial real estate office, et cetera. Everybody knows about that. But it's still going to be an issue. So I think they've got to wade through that.

I don't worry about that much because. Everybody knows about credit. Everybody's dealt with credit for a long time. I've been doing this for 40 years. We've had credit cycles. I think the boogeyman is-- or the real new issue is what's going to happen to the deposit side because since the Silicon Valley first republic issues of a year or so ago, the deposit side has really been exposed as a risk factor for the industry that we've never had. So you see most of these large banks losing noninterest bearing deposits to the market, and I'm not sure where they're going or where they're ending up.

But that really is the Golden Goose of this industry, or these low-cost deposits that they can fund, reasonably low-risk loans with to make a decent return over time. Lever it up, and do OK. And that covers a lot of sins with some of the other more risky stuff they do. But if they continue to lose that, That's going to be a long-term problem for them in terms of margins and overall profitability. So if I worry about anything now, going forward, it's going to be what's going to happen to those deposits and what are those deposits going to cost them long term?