The C-Suite Speaks: Banks See Strength
by Scott Krisiloff, Avondale Asset Management
Each week our team at Avondale Asset Management reads dozens of transcripts from earnings calls and presentations as part of ourĀ investment process. Below is a weekly post which contains some of the most important quotes about the economy and industry trends from those transcripts.
The first full week of earnings season is always filled with reports from the nationās banks. Banks typically give the best read on the economy of any industry and for now they sound relatively upbeat. Outside of energy, credit has remained strong and management teams areĀ optimistic about prospects for loan growth. Still, thereās reason to be skeptical. Banks were so beaten up in the last cycle that itās possible the reason they are seeing strength now is that they never really overextended themselves in this one. Weāll look for confirmation this week as earnings season hits its busiest point.
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The Macro Outlook
Thereās a lot of pain in the industrial economy.
āWe sell across the continent, around the planet. Most of our business is in North America and we sell to a lot of different industries. And when you start looking through the list, of lot of names that you recognize stand out and you can see the pain they are feeling in their business.ā ā FastenalĀ president and CEO Dan Florness (Industrial Distributor)
Union Pacific has seen a dramatic drop-off in volume.
āIt is hard for me to speak and predict on whether the economy is going into a recession. Certainly our volume drop off as the 2015 year progressed quarter to quarter and as we are entering 2016 is dramatic, and it is dramatic in historical reference . . . A 6% decrease year-over-year and a quarterly 6%, 7%, 8%, 9% decrease year-over-year is pretty dramatic volume change.ā ā Union Pacific chairman, president, and CEO Lance Fritz (Railroad)
Whatever industrial companies are seeing, the banks perceive a very different picture.
Most banks see the economy holding up pretty well.
āWhile parts of the global economy have continued to experience stress and the markets have reacted negatively in the early weeks of 2016, domestic economic conditions remain generally favorable.ā ā Wells Fargo chairman and CEOĀ John Stumpf (Bank)
BB&Tās CEO said that thereās a lot of overreaction going on.
āThereās been a lot written and said over the last few weeks about the issues in the stock market. We believe thereās a lot of overreaction going on. Itās like you woke up January 2, all of a sudden everybody decided the worldās falling apart, and we reject that. We donāt see any fundamental structural changes between the first part of December and the first part of January. The world just doesnāt happen that fast.ā ā BB&T chairman and CEO Kelly King (Regional Bank)
Delta expressedĀ a similar sentiment.
āWeāre pretty optimistic relative to what you read on CNBC or Wall Street Journal or some of the thunders out there that are predicting the future. We are booked ahead in terms of load factor for each of the months for February, March, April, and really add into early summer.ā ā Delta CEO Richard Anderson (Airline)
Outside of energy portfolios, there hasnāt been any deterioration in credit.
āNegative credit migration in our energy exposure continued as expected. . . .The remainder of the loan book continues to perform well.ā ā Comerica chairman and CEO Ralph Babb Jr. (Regional Bank)
āOutside of energy, we are not seeing asset quality change nor are we seeing a reduction in appetite for our credit. . . . We continue to see a lot of opportunities that help our customers grow their businesses.ā ā Bank of America CFO Paul Donofrio (Bank)
And everyone is quick to point out that lower oil prices should invigorate the economy.
āYes, oil is down and that is a factor in terms of the oil space, but oil is overall really stimulative. Itās stimulative to consumers. Itās stimulative to businesses. Itās stimulative to airlines. Oil is stimulative.ā ā BB&T chairman and CEO Kelly King (Regional Bank)
āIn this instance, cheap oil is a net stimulative impact on US growth. A WorldCom fraud was not beneficial for everybody else in the US. Telecom didnāt get cheaper. But fuel has gotten cheaper, which is good for consumers.ā āWells Fargo seniorĀ EVPĀ and CFO John Shrewsberry (Bank)
āIt feels like the degree to which the market is focused on energy exposure has managed to discount the long-term tailwinds to the consumer in a reduction ofĀ costs across the globe.ā ā Goldman Sachs EVP and CFO Harvey Schwartz (Investment Bank)
The lending environment appears to still be very competitive.
āIn terms of the market itās kind of interesting. We characterize it to still be intensely competitive. . . . Pricing in mostĀ markets is still coming down slightly. Itās not stable but itās still coming down. Smaller banks are routinely below 200 basis points in terms of margin, maybe 150 to 160 basis points. Weāre seeing places where there is no recourse, limited covenants, and in some cases people waiving due diligence.ā ā M&T Bank EVP and CFO RenĆ© Jones (Regional Bank)
Still, it would be foolishĀ to claim that conditions are improving.
āItās tough out there. Thereās no doubt about it. It would be irresponsible to assume that itās getting better right now. The year has certainly started more volatile. There are some major issues that need to be solved in the global economy to get the growth back.ā ā Unilever CEO Paul Polman (Consumer Packaged Goods)
It is a tense environment.
āLook, obviously the first couple of weeks of the year have been difficult from a market perspective, and the last half of the year, and continuing the dramatic decline in commodity prices broadly has been disruptive for the market. I think if you talk to our folks, obviously that sector prices remain where they are, itās going to be under stress. Thatās an inevitability.ā ā Goldman Sachs EVPĀ and CFO Harvey Schwartz (Investment Bank)
Even bullish bankers say that activity is on the weak side.
āWhile we donāt think the economyās tanking, we donāt think itās going to be super robust either. Itās kind of a slow, steady-as-you-go activity.ā ā BB&T chairman and CEOĀ Kelly King (Regional Bank)
āAlthough the US economy is improving slowly, revenue growth remains challenging. This quarter we continued our progress on those things we can control and drive.ā ā Bank of America CFO Paul Donofrio (Bank)
āIām not going to say itās robust, but weāre really happy weāre all-in in the US. Letās put it that way.ā ā Wells Fargo chairman and CEOĀ John Stumpf (Bank)
Bankers who have recently met with customers report increasing apprehension.
āFrankly, as recently as just the last few days, I have had interaction with a number of clients in the marketplace. So I think this is pretty contemporary feedback. We are seeing a growing sense of caution from our client base. And frankly, that is really across almost all of our businesses.ā ā Fifth Third Bank EVP and COOĀ Lars Anderson (Regional Bank)
Itās a deflationary environment.
āIn a low growth and deflationary environment, we have to work the cost part of the equation harder.ā ā Unilever CEO Paul Polman (Consumer Packaged Goods)
Companies are still trying to right size inventories.
āI think across the board, you hear every customer talking about trying to right size their inventories.ā ā Union PacificĀ EVP of marketing and salesĀ Eric Butler (Railroad)
Itās going to be hard to generate record earnings.
āWe are going to fight like heck to do the best we can. But yes, you are correct. At this point in time, we do not see record earnings.ā ā Union Pacific CFO Robert Knight Jr. (Railroad)
Institutional investors are showing apprehension.
āWeāve seen a bit of a softness in the VC market, thatās because firms are exercising more caution following several years of really strong investment and high valuations. There had been some challenging verticals, like cyber security ad-tech, but ā so weāre watching that carefully.ā ā Comerica EVP,Ā business bank, J. Patrick Faubion (Regional Bank)
Retail investors donāt seem to be too concerned though.
āSome of the widening of spreads or the fears of higher rates are going to produce some selling, possibly from retail. But we havenāt seen anything dramatic yet. We havenāt seen really any dramatic outflows on iShares yet.ā āBlackRock chairman and CEO Larry Fink (Asset Manager)
The average investor is laying low for the moment.
āWhile trading is up and the number of clientsĀ trading isĀ up as well, we are still seeing a wait-and-see attitude from the broader client base. Those who are trading are doing so quite actively, but the average investor is waiting to see which way this market will turn next.ā ā TD Ameritrade CEO Fred Tomczyk (Retail Brokerage)
International
Currency could have an even greater impact on profits this year as hedges expire.
āCurrency continues to be a significant headwind. . . . Given the sustained period of dollar strengthening, the profit impact in 2016 will in, fact, be greater than 2015, both because of the translation impact and the roll-off effect of cash-flow hedging gains.ā ā IBM senior vice president and CFO Martin Schroeter (Enterprise Tech)
Intel representatives in China is seeing things that are making themĀ uneasy.
āOur team on the ground in China has gotten fairly cautious about whatās going on in China right now. And as you know, that is the largest PC market, so we are just a little cautious on the growth rates there.ā ā Intel EVP andĀ CFO Stacy Smith (Semiconductors)
India has been hit by a second weak monsoon season in a row.
āCrop failures for a second consecutive monsoon failure have put pressures on rural demand in India.ā ā Unilever CEO Paul Polman (Consumer Packaged Goods)
Netflix is a luxury that only exclusive segments of the worldĀ can afford for $8ā$10 per month.
āWell weāre starting off definitely appealing to elite. I mean I mentioned that in Russia and Eastern Europe, you know, weāre still in English. In Vietnam and Cambodia, weāre in English. So weāre serving elites. You can think of them as a shorthand as iPhone owner, so that they pay $800 for an iPhone. They are comfortable with entertainment in English, and so for them, you know, $8ā$10 is a sweet-spot price.ā ā Netflix CFO David Wells (Streaming Video)
Financials
Interactive brokers called out something strangeĀ going on in Treasury markets. Three month T-Bills are trading well under the federal funds rate.
āAccording to the new banking regulation, these type of financial deposits this year will have to be secured by Treasuries even of the banks, which may result in a squeeze on Treasuries. Indeed, we see Treasuries maturing within three months currently being traded well under the Fed fund rates.ā ā Interactive Brokers chairman and CEO Thomas Peterffy (Retail Brokerage)
M&T Bank noted higher delinquencies in the indirect auto space.
āThe only place, and itās not in M&Tās book, on a national level, where you see both higher spreads and higher delinquencies, is in the indirect auto space.ā ā M&T Bank EVP and CEO RenĆ© Jones (Regional Bank)
Low organic growth has been a key driver of M&A activity.
āWhat are the factors that drove the M&A environment over the past 18 months and are they still in place? And those core factorsĀ [are]Ā really limited organic growth, companies were struggling to find top-line growth. You had positive but modest economic growth in major economies, and companies had done quite a bit of work both on cost and refinancing going into that cycle and there was high level CEO and board confidence.ā ā Goldman Sachs EVPĀ and CFO Harvey Schwartz (Investment Bank)
Several banks said they are not looking to acquire other banks.
āAs it relates to traditional bank M&A, we are not interested, we are not involved. There is a variety of reasons youāve heard me talk about before. Sometime through time could that somehow change? Sure, because forever is a long time. But today itās not on our radar.ā ā PNC Bank chairman, president, and CEO Bill Demchak (Regional Bank)
Banks are overcapitalized.
āSo our thought process is that our optimal capital structure is definitely lower than where it is at today. But weāll have to work our way through the CCAR [Comprehensive Capital Analysis and Review] and go through that process.ā ā M&T Bank EVP and CFOĀ RenĆ© Jones (Regional Bank)
Morgan Stanley is making significant restructuring moves in its fixed-income trading business.
āGiven the cyclical and, in some cases, structural challenges facing fixed income, driven by the work . . . we took the decision to downside headcount by 25%, along with our ongoing balance sheet and capital focus. We took this action alongside the recent installation of a new management team with the objective of credibly sizing the business going forward.ā ā Morgan Stanley chairman of the boardĀ and CEO James Gorman (Investment Bank)
Financial adviser growth has slowed (probably because retail investors are doing well).
āThe retail asset gathering is slightly up year over year and the institutional side is down. The institutional side is down largely to existing advisers. They are continuing to grow, but they are not growing as fast as they did last year at the same time. . . . In our discussions with them, itās much more the market environment. It really is basically the market was essentially flat last year, so itās hard to differentiate yourself.ā ā TD Ameritrade CEO Fred Tomczyk (Retail Brokerage)
Driverless cars and other developments could lead to big changes for the insurance industry over the coming years.
āWhatās going on with any of our competitors or whatās going on with technology or big data or driverless cars, consolidation among distribution, you could go on and on. I think what I would share with you is weāre very aware and deeply engaged . . . But as we think of everything thatās got the potential to change in this marketplace, nothing is going to change overnight. These are things that are all going to evolve and develop overtime.ā ā Travelers CEO Alan Schnitzer (Insurance)
Consumer
Brinker experienced more divergenceĀ from region to regionĀ among consumers at its restaurants.
āIt is important to note, we saw considerably more regional variability during the quarter than weāve seen traditionally. Some parts of the country performed significantly better than others, though none as strong as weād like. Chiliās is deeply penetrated in areas like Texas and Louisiana. Theyāre dealing with economic pressures linked to declining oil prices.ā ā BrinkerĀ International CEO and president Wyman Roberts (Restaurants)
Middle market brands are disappearing in the United States along with the middle class.
āWe think that these prestige brands, small as they may be, are well positioned. . . . The US is a great example. . . . GDP growth goes to a very small amount of people and theyāre not eating more products. The middle market is disappearing, which is the bulk of the business. Thatās why you see a lot of retailers struggling. But the prestige segment is continuing to grow amongst that target and weāre very well positioned for that.ā ā Unilever CEO Paul Polman (Consumer Packaged Goods)
Verizon says itās too early to tell whether people are upgrading their handsets more slowly because of the switch to installment plans.
āWell, for our base itās too early to tell because the first generation of them are just starting to mature. Until I get some real factual data on that, itās hard for me to answer. My own personal opinion here is that if you look at history, a third of your customer base upgrades every year. I donāt see that changing, regardless of what plan the customer is on.ā ā Verizon EVP and CFO Francis Shammo (Telecom)
Technology
Logitech saw strong demand for its iPad Pro accessories.
āThe bright spot for us in Q3 was the strong sales of our CREATE keyboard for the iPad Pro. Demand exceeded supply during the quarter due to the strong initial reception.ā ā Logitech president and CEO Bracken Darrell (Consumer Electronics)
ARM has not been able to displace x86 in servers as easily as some expected.
āThe datacenter market is really, really interesting. . . . I think x86 has a lot of momentum. . . . I think ARM does have a lot of specific areas where it can contribute and it has done so. But I would say in servers, in particular, perhaps slower than originally expected, but still something to watch for the medium term.ā ā AMD president and CEO Lisa Su (Semiconductors)
The Weather Company handles seven timesĀ as many queries per day as the worldās largest search engine.
āThis platform can handle enormous complexity, taking in four billion weather forecasting points and 26 billion queries in its cloud service each day. This is the fourth most-used mobile app, handling seven times more transaction volume than the worldās leading search engine.ā ā IBM senior vice president and CFO Martin Schroeter (Enterprise Tech)
Materials, Energy
The Texas economy has proven to be surprisingly resilient.
āHouston has weathered in many respects this transition far better than many thought, including me. I give Houston a lot of credit. They are quite resilient.ā ā Texas Capital Bancshares president and CEO C. Keith CargillĀ (Bank)
Energy companies have continued to hedge their oil price exposure as prices have fallen.
āRight now weāve 59% of our borrowers that have 50% or more of the revenue hedged out one year and then drops off to 30% after that. . . . Now the value of those hedges has dropped . . . but I think the good thing here is that borrowers are actively working to extend the runwayā ā Comerica EVP and chief credit officer Peter Guilfoile (Regional Bank)
No one expects oil to remain below $30 for long.
āI donāt think itās the view of the industry at this point that oil is going to stay sub-$30 for any length of time.āĀ ā Regions Financial chief credit officer Barb Godin (Regional Bank)
The oil price should eventually hit a capitulation point.
āHistory indicates usually youāll hit a capitulation point, a bottom, and it doesnāt just slowly return to a better price level. Now, this time thereās some unique aspects of shale production, where thereās been quite a lot drilled and not completed and thatās a little bit of an unknown certainly. But overall we think that $35 that we used most recently is realistic today.ā ā Texas Capital BancsharesĀ CFOĀ Peter Bartholow (Bank)
But the appetite to lend to energy companies has gone away.
āCapital markets were actually, as you know, were quite open for energy companies very early in this. And that has gone away. . . . Maybe itās this incremental leg down to where weāre on crude prices that has people generally believing that this could be where weāre for a longer time.ā ā Wells Fargo senior EVPĀ and CFO John Shrewsberry (Bank)
Full transcripts can be found atĀ Seeking Alpha.
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