Banking crisis 'woke the sleeping bear' as customer deposits remain in focus: Analyst

Raymond James Managing Director of Equity Research Michael Rose joins Yahoo Finance Live to discuss the banking crisis, bank earnings, and what's next for regional banks.

Video Transcript

- Investors are keeping a close eye on banks this earnings season amid the recent turmoil in the sector. And it was a rough day for State Street. Shares ending the day down more than 9% lower after the bank missed estimates on both the top and the bottom lines. Joining us now, Michael Rose, Raymond James managing director of equity research. Michael, is the banking crisis over?

MICHAEL ROSE: Hi. Thanks for having me. Yes. We think we are moving from the crisis phase to the stabilization phase. And I think as we move into earnings season, what we're going to see is trends that we expected to envelop as the banking crisis did play out, which is deposits, deposits, deposits, meaning flows, deposit flows, deposit costs, and the mix of deposits changing from those that are non-interest bearing to interest bearing as we essentially believe that through this crisis, through the Signature and Silicon Valley Bank failures that we kind of woke the sleeping bear as it relates to those that had not yet look to ask for a better rate from their bank deposit side. We think this crisis spurred that action among small businesses and consumers. And we believe as earnings season plays out that these trends will become much more apparent as the regionals and the smaller banks begin to report.

- Yeah. We've seen certainly deposits slip a bit across the board. But no huge damage from the banking crisis. But I would say yet, as a lot of analysts feel maybe the damage is way down the road when conditions begin to change over time, that we haven't seen it yet because the damage hasn't been baked in. When will we see the true impact of what happened with SVB? And what will it be?

MICHAEL ROSE: Yeah. So we continue to believe that the two banks that failed-- Signature and Silicon Valley-- were idiosyncratic in nature. They had specialized business units that were concentrated in specific industries. When you look at the industry at large, we actually think the deposit flows have actually begun to stabilize.

And just looking at the Fed's annual-- or, excuse me, weekly-- balance sheet report, you can see that in each of the past two weeks small bank deposits have actually increased. And we think that is very, very important as we move through the next few months to quarters. Again, we think the bigger issue is the change in mix from those that had deposits sitting and checking accounts that are now moving to an interest-bearing account, and then also the cost of those deposits just given the upward pressure on rates' competitiveness and then in the face of the Fed looking to raise potentially one more time before taking a pause.

- So if market watchers are looking at a bifurcation perhaps of the big banks and the regional banks as we were coming into this earnings season, is that bifurcation not as severe perhaps as one would have expected?

MICHAEL ROSE: Yeah. We don't think it's as severe. Clearly, the regionals have been under an inordinate amount of pressure. If you go back to Friday, you had Citi, you had JPMorgan both beat on the top and bottom line. The shares were up fairly considerably, outperforming on the day. But the regionals and the smaller banks did lag. Today, we've had quite the reversal. And, again, we think this marks the shift from the crisis phase to the stabilization phase and realizing that things aren't all that bad. There are definitely headwinds in the form of net interest margin pressure, slowing loan growth, pressure on expenses, and fee income businesses, which have been soft. Those are earnings headwinds. We don't think they are liquidity or capital headwinds. So given the sell off that we've had in banks over the past five or six weeks coupled with the underperformance that we've had last year, there are some relatively attractive valuations. We would say that concerns on credit are persisting and just beginning to pick up. So we think that is going to keep investors at bay for now. So valuations will remain depressed in kind of the short to intermediate term. But once we figure out how bad credit will be, we actually think that you can perhaps begin to look at this sector, which has been an underperformer for quite some time.

- Speaking of, the Treasury Secretary Janet Yellen speaking to Fareed Zakaria at CNN said, quote, "banks are likely to become somewhat more cautious in this environment. We already saw some tightening of lending standards in the banking system prior to that episode. And there may be more to come." How do you expect that story to play out?

MICHAEL ROSE: Yeah. We definitely believe that there is going to be a slowdown in loan availability and, therefore, loan growth at the banks given just what has happened here over the past five or six weeks. We believe that it is accelerated what was already beginning to play out. Concerns around a recession had been building for the past several months.

This likely has brought them forward. And given the increase in deposit costs that banks are being forced to pay, the new loan yield that banks are underwriting new loan production at have definitely moved higher, in some cases in a market way just over the past five or six weeks. So we think that the buyer-- or excuse me-- the customer, whether it be business or consumer, willingness to take on new credit at 7%, 8%, even 9% in some cases is certainly less so than it was at 4%, 5%, or 6%. So by definition, we think that lending activity will likely slow over the next month to a few quarters.

- And do you see that slowdown happening in certain areas? For example, we spoke with Jerry Howard, the National Association of Homebuilders, and he was saying that the lending in commercial-- or the lending, excuse me, for builders has been a concern. We've got that concern. Then, of course, we've got the commercial lending as well. So which areas are you seeing that there might be more tightness?

MICHAEL ROSE: We think it's going to be fairly broad based. So the consumer spending that's happened since COVID appears to finally be slowing. The excess cash that was built up during the pandemic through a variety of stimulus programs is being run off, given the impact of inflation. On the small business side, continue to see some pressure. But I think what you're probably getting at is concerns around commercial real estate, and more specifically office. That is an area that has dominated news headlines here over the past three to four weeks.

Commercial real estate, though, is a very broad asset class. And so we can certainly understand the concerns around office in metro markets. But I think, overall, there's going to be less just commercial real estate in total just given increasing signs that the economy is beginning to slow down. Again, we don't think it's going to fall off a cliff per se. But definitely a slowdown. And we'll have to determine over the next few quarters if we actually do approach a recession.

- All right. Got to leave it there. Michael Rose from Raymond James. Good to see you, man. Thank you.