Earnings season is now in full swing. Banks led the way with a flurry of earnings reports reflecting key themes in the global economy:

  • The trade war is a constant worry for corporate clients and we are just beginning to see the financial markets impact.   
  • The US consumer economy is strong, but bank executives are seeing signs of growing unease. 
  • Banks are in a technological arms race that will require significant ongoing investment to stay competitive

BLX Bank Indexes

Against a backdrop of geopolitical concern, it was a better than expected quarter for the banks tracked by the BLX family of indexes. The BLX Bank Revenue and Bank Earnings Indexes provide pure exposure to financial performance of the US Banking Sector. The performance of these indexes reflect consumer, business, and capital markets activity centered around the US.

Bank Earnings

Aggregate total earnings for index components were 4.5% higher than analyst expectations according to I/B/E/S Refinitiv. Overall, 68% of the companies in the BLX Bank Earnings Index reported upside earnings surprises

Bank Earnings Surprises 2019Q3

Source: Refinitiv

Bank Revenue

Aggregate total revenue for companies in the BLX Bank Revenue Index came in 2.4% above analyst expectations., with 68% of the companies reporting upside surprises. Notably, some companies that disappointed on earnings provided upside surprises on revenue.

Bank Earnings Reports contained upside revenue surprises in 2019Q3

Source: Refinitiv

Banks will follow up these earnings announcements with full financial statements in the 10-Qs, the index levels will reprice, along with and any options products using them as a reference asset.

Key Themes from Bank Earnings Calls

Earnings reports from US money center banks provide an essential vantage point for understanding the economy.

Who’s Afraid Of A Trade War?

The trade war was a constant theme in bank earnings reports.

Goldman Sachs  CEO David Solomon is seeing the trade war impacting its clients:

The operating environment in the third quarter remained mixed and slowed the pace of activity by many of our corporate clients.

During the quarter, trade war concerns contributed to a risk-off sentiment and sharply lower global interest rates, particularly in August. Markets were also impacted by turmoil in Argentina, Brexit headlines in Europe and a temporary spike in oil prices in September. Throughout the quarter, responses from central banks, including the Federal Reserve and the ECB, remained accommodative, supporting both capital markets and the sustainability of global economic growth. Looking forward, our economists continue to expect global GDP growth in excess of 3% for this year and next. That said, global growth is not without risk as trade issues remain challenging.

Likewise, JP Morgan’s  CFO Jennifer  Piepszak expressed similar concerns:

So on client sentiment, I think it’s fair to say that perhaps the marginal investment is being impacted by trade fatigue in terms of the uncertainty.

Morgan Stanley ‘s CEO James Gorman was also expressing near term caution as a result of the trade war.

Overall, we remain cautious today as trade talks swirl and interest rate paths continue to be debated, but expect us to look beyond the next few months and focus on continuing to enhance the stability of the franchise and growing the business. Our job is to continue to manage this institution for the long term.

The Consumer Economy

The US Economy is strong.  Based on bank earnings calls, strong consumer franchises were a key differentiation during the quarter.  Although bank executives were optimistic, they all expressed concerns about a possible weakening of the US economy.   A major slowdown would hit banks at the top and bottom line.

Morgan Stanley’s CEO is optimistic about the US economy.

So I think there’s still a sense where despite all the naysaying and all the news and all the pundits, the reality is the U.S. economy is in good shape and the consumer balance sheets are in good shape. 

JP Morgan’s CFO expressed similar sentiments around growth: 

 But broadly speaking, while it’s slower growth, it’s still growth. As I said, the U.S. consumer is incredibly strong. Consumer spending is strong. Sentiment is strong for the consumer, credit is good. And it is true that if you look at the ISM surveys, both manufacturing and nonmanufacturing, they were recently disappointing. So I would say, no doubt, cautionary signs, but credit remains very good, and there’s still very healthy business activity.

On the other hand, after reporting a disappointing quarter, Goldman’s CEO  emphasized downside risk:

….That said, recent data suggests slowing in manufacturing and industrial production. Mindful of that, we remain vigilant of where we are in the economic cycle and conscious of it as we manage risk across our firm. In my regular conversations with CEOs, there is considerable focus on the duration of the current economic cycle. While most CEOs remain focused on growing their businesses and capturing opportunities amid the disruptive forces of new technologies, geopolitical issues continue to give rise to some caution. 

Investments in Technology

Banks are increasingly in a technological arms race. In order to remain profitable they need to drive down costs with automation. In order to attract clients and their assets, they need to have state of the art systems set up.  Technology is commoditizing many banking functions.  Table stakes are about to get a lot higher for bank IT systems.

For example, here is Morgan Stanley:

Clearly, portfolio construction and execution costs have been commoditized, and so we’re trying to provide financial planning and service to our clients. We’re really doing it with our technology around 4 places: advice, service, relationship management and asset acquisition.

On the asset acquisition side, I would say the best or the most impactful technology we have is really around both asset aggregation and our risk analytics. It allows us to do stress scenarios and testing real time. So it’s not paper-based on different scenarios and look at concentrations. And once we have a much better picture of all our clients’ assets with our asset aggregation tools, we found that we’ve had an ability to attract more of their assets. So it’s really around the technology that we’re developing to try to drive that asset acquisition. And then we’ve enhanced our digital experience. We’re enhancing our client experience, and we think all of that leads to a better ability to attract those assets.

JP Morgan is also making heavy investments in technology:

 We haven’t laid that out in terms of quantifying it, but some of the things you can think about are robotics replacing repetitive processes. You can think about machine learning or AI in fraud. So machine learning assisting us in decision-making processes. Our call centers are always getting more productive.

….. And then digital capabilities that we’re rolling out to our customers in terms of self-service is not only better for them, but more efficient for us. And so we have realized significant productivity to date in not only in our technology investments, but other investments, and think we still have room to run.

Generally, all banks have similar initiatives in process.  These tech investments create tension with sell side analysts and the industry emphasis on quarterly earnings.  They all require a lot of money up front, and take years to come to fruition.  However, many of them won’t work. Investors with an edge in analyzing the technological initiatives in banks might consider an options trade directly on bank earnings as a way to express a long term view on the benefits of these initiatives, without exposure to interim changes in the stock price.

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