Everything is awesome … for banks

0:05Pushkin. On Wall Street, Christmas comes not once but four times a year. Every quarter we have earnings season and investors and analysts get to unwrap the results from their favorite companies. Well, Christmas in July is here. Second quarter earnings season is beginning, and it is beginning, as it always does, with an avalanche of bank results. Just this morning, we had JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs. And all of them reported very healthy numbers. This is Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin. I am Rob Armstrong, beaming to you from Unhedged World Headquarters in downtown New York City.

1:05And today I'm lucky to be joined by head of the Financial Times Lex column and famous office shorts wearer, John Foley. Hi, John. Hi, Rob. Are you wearing shorts today? No, I'm wearing jeans. I'm wearing full length jeans today. No, but our producer, Jake, is wearing shorts. That's the important thing. John, let's just count the ways that banks can make money from a booming tech world. So the most obvious one, equity offerings. A huge company like SpaceX does an IPO. The banks on the deal take a fee, 7 % of the total or whatever it is. That's just money straight in the door. What else should we think?

1:43John Foley: Well, a big source of profit, this quarter has been trading stocks, right? So they trade stocks on behalf of clients. They take a spread basically between the buy and the sell price. and they also do a lot of lending to hedge funds and other investors. And that's a big part, especially for Goldman, is making short-term loans. And then there's also the advisory business, which is basically M &A, right? Helping companies buy each other. And those fees are not as exciting as equity right now, but they are all up at all of the big banks except for Citigroup. So I don't know where to start with these numbers.

2:12They were awesome from the banks. Everyone was expecting great numbers and these were even greater.

2:16John Foley: What really stood out to you? Well, they are great numbers. So the profit numbers are very healthy. Revenue is growing very rapidly. It's kind of crazy when you think that companies like Bank of America, for example, huge, very old, slow-moving lender is growing its revenue at 15%. Yeah. That's how fast Microsoft is growing. Yes. So really, these companies have had a kind of second crack at youth. And one of the things that's driving this, the main thing that's driving it is tech. Big deals like the SpaceX IPO that created a bonanza of fees. Markets are just very exuberant at the moment. So equities trading is going great for all of these banks.

2:53So equity trading revenues, JP Morgan up 86%. Bank of America up 70%. Citibank, who's terrible at trading equities, by the way, even their equity trading revenues was 45%. Goldman, 72%. So there was a bonanza on the trading desks for reasons we've been talking about on this show for a long time now. SpaceX IPO, mad churn in chip stocks, the list goes on. But I want to note some other good stuff here. Card volumes, meaning how much are people spending on their debit and credit cards. J.P. Morgan, Bank of America, Citi, three big issuers all up in double digits or near double digits. So consumers are out there spending money.

3:45Credit quality was pretty good too. I didn't notice anything going sour out there in terms of loan quality. Did you?

3:53John Foley: No, and actually the credit costs, so the amount that the banks have to put aside for bad debt went down at definitely Bank of America and J.P. Morgan, who are two of the biggest card issuers. And net interest income, meaning the difference between what they pay for their money and what they earn on their money, which is, of course, what a bank is. It pays for money in one place and then sells it someplace else for slightly more money. Those all rose at a healthy rate. Net interest income results were all up in the double digits. So incredible quarter all around. And yet, the stocks aren't up very much in early trading this morning.

4:34What's going on there, John?

4:35John Foley: Well, if you look at how the bank stocks have performed this year, they've done really well. None of this is terribly surprising, I think. We've known that banks are doing very – we've known the economy is in a pretty benign state. We've known that AI and hyperscalers like Alphabet and Amazon are generating a bunch of fees and all the capex and investment in data centers is keeping the economy humming. We also know that regulation, which has been a kind of a burden on the banks for a really long time, is getting much easier. The administration's tone has changed dramatically. Automatically, the Federal Reserve, which leads the regulatory charge, has basically warmed to the industry that it polices.

5:12So the short answer, why aren't the stocks up more on these great results? They're already expensive. Yeah, they're all expensive. And everybody expected results to be very good.

5:20John Foley: And it's particularly, if you look at Goldman Sachs and Morgan Stanley, which are the two that are most geared towards equities trading and deals, they're trading at something like three times their book value now. And price to book, like a bank might trade at one times book value on a good day. Yes. Three is a lot. I should explain for our listeners what book value is. It's nothing more or less than the net worth of the bank. It's assets minus its liabilities. So if you're paying three times book value for Goldman Sachs, you're paying three times what it actually owns, meaning that's a, you know, it's a big premium.

6:01and the premium suggests you expect big growth in what the bank owns in the future. So the bank stocks are all very expensive. They've had a nice run, especially in the last couple of months. And the market was basically prepared for excellent results and the banks delivered. Now, you said something that was very provocative, John, and I want to get back to it. We've rattled on at some length on this show about the question of whether all American prosperity is just a side effect of this enormous tech bubble or possible bubble that we're living in. Do you think these bank results simply reflect a world that is pumped up on AI?

6:50Is that fair?

6:51John Foley: I think that there are two parts to that. One is that these banks specifically are pumped up by stuff that is connected to AI. So individual deals and activity by clients who are tech companies. Yes. Like issuing bonds. Look at how the big tech companies are dominating the bond markets as well as the equity markets. Correct. There's that. So there's also the fact that AI is taking up an increasing share of the overall investment that's happening in the real economy. So Jamie Dimon, who's the CEO of JP Morgan, today was throwing out some kind of back of envelope numbers saying that capex, capital expenditure is going to be about$4 trillion this year.

7:30John Foley: And capex for AI is going to be about$1 trillion. And these are very round numbers, but it means a quarter of all spending. I want to scale that because I was writing about this a bit yesterday. $1 trillion is the budget for the Department of Defense. so we are spending as much in this country on ai capex as we are on the military which is just it's just hard to to get your head around that it's a lot of money and that and that feeds into lending activity just general stuff yes and jp morgan also kind of warned today that some banks may be making what they call relationship loans to people who they want to court but who maybe you wouldn't normally lend to on normal time.

8:17So that's an indirect way. My view of these big banks, actually, John, is that increasingly most of their loans are relationship loans. In other words, the way to be a very profitable big bank is to earn a lot of fees, either from doing investment banking work or getting fees for initiating loans or trading stuff or whatever it is, and then you use your balance sheet, your actual lending power, just to build relationships to get those fees, right? So it's like the balance sheet is a supplementary tool you use to earn fees. This is neither here nor there. The question is, is there more to this than tech?

8:57And I guess there is a consumer who is out there spending, which helps a lot. Yes.

9:03John Foley: Well, there's the wealth management business, which is also, again, benefiting from tech because exuberant markets and rich people who've just made loads of money on the SpaceX IPO, or maybe not so much if they are still holding the shares. But there is also, I think, a sense that the views of where the economy are going are quite positive. And I think AI is a big part of that. Like, look at the Federal Reserve, look at Kevin Walsh at the Federal Reserve, who believes that AI will keep wealth growing, but inflation sort of under control. So this, like, broadly benign view encourages people to take a bit more risk and spend more money.

9:35John Foley: And no one's really lost – I'm not going to say no one's lost their job, but job losses have not been severe from AI yet. So we kind of feel like – You can't see them in the aggregate job numbers. So I do think the economy is being held up by AI and the views of what AI can do. And if the bubble were to burst, you'd definitely get a resetting of GDP growth expectations, which would be bad for everyone. Worth noting that we got a benign CPI inflation report this morning, which supports that whole picture you just outlined. But all is not green and rosy in technology land. We also had a report from IBM this morning, which you may remember is a computer company from days of old that still makes big mainframe computers that companies use.

10:19Its stock is getting crushed this morning. It had a bad report because its customers are buying other stuff. Isn't that kind of how we read that report?

10:29John Foley: It seems so. they seem to be saying that their customers are safe kind of saving their money for data centers and chips and that kind of stuff and therefore they may be delaying spending on software the thing that IBM reminds us is that like the timing of money matters so IBM isn't saying that people aren't going to buy software they're just saying they're kind of delaying it and they might buy it next year instead of this year and but that matters a lot when you're looking at company valuations that have priced in cash flows coming at certain times because future cash flow is worth less than today cash flow.

11:03John Foley: So if we're entering a phase where lots of people are postponing projects, that's going to have a really big impact on the valuation of companies that are priced as if the cash is coming tomorrow. So John, to sum up, what did we learn this morning? Well, we learned that it's great to be a bank right now in America, but specifically in America, we'll have to see what happens in Europe where AI is not a thing on anywhere like the same level. But the investors already know that it's great to be a bank. So they are moderating their excitement. But we also know that the banks really are, they've hitched their wagons to Silicon Valley in a big way.

11:37John Foley: So what happens next with AI and tech valuations is going to ping back on them one way or another. Listeners, we'll be right back with Long and Short.

12:01Listeners, welcome back to the show. This is long and short, that part of the show where we go long things we like and short things we don't like. John, do you like something or not like something today? I like, and so I'm going long, being unserious about serious things.

12:19John Foley: This is inspired by Count Binface. You are the second person. Katie likes Binface too. I'm like watching it from the US, as you are, right? And it's just, it's fascinating how Britain is making a sort of humorous point over something that really isn't very funny. Funny at all. Yeah. The whole situation. To remind listeners on this side of the Atlantic, Count Binface is running, is it for a local council seat he's running for? What does he run for? He's running in Nigel Farage's seat in Clacton. And he literally wears a giant trash can on his head. Katie Martin has already expressed her enthusiasm about this trash can wearing maniac.

12:54I think that finance needs more.

12:56John Foley: It needs a count bin face. I think people would vote in shareholder elections more than they do because they don't, right? Retail investors never vote. Maybe they would if we had more joke candidates. Yes. Maybe if count bin face stood against. Should run to sit on the board of Meta. Exactly. I'm ready to vote for that right now. On a not totally dissimilar vein, I am long farmers windfalls from AI. There was a nice article in the Wall Street Journal the other day about farmers being offered vast fortunes for their land because companies want to build AI data centers on what used to be hog farms.

13:42and although I don't, you know, I have everyone else's mixed feelings about the AI boom and data centers and our tech overlords, I like the idea of a hog farmer suddenly becoming fabulously wealthy because Elon Musk wants to give him money. Listeners, Unhedged and its own vast fortunes will be back in your feed later this week. In the meantime, stay cool and listen up then. Thank you.