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Wells Fargo and JP Morgan earnings are on deck for tomorrow mortgage rates continue to skyrocket and David and I we're placing some bets buckle your seatbelts folks because this is where the money is Matt you mentioned in the intro that interest rates skyrocketing earnings tomorrow for some of the banks is it gonna be a bloodbath what do you think I think in some ways we're going to see some big hits on the banks in particular on the balance sheet the all of the banks right now have huge security portfolios most of that is fixed income when rates go up prices go down in the fixed income market that's gonna lead to losses on the book and since we value bank stocks based on book value multiples that's going that you know that has an impact on valuation yeah I'm certainly gonna be watching OCI as well I'm also gonna be looking at some of the things above the line particularly mortgage banking you look at Wells Fargo JPMorgan these two are one and two in terms of mortgage originations in the US and with rising interest rates refinancing which has been the big driver behind a lot of these gains has been falling off a cliff I think it's down around 50 percent from that's the Mortgage Bankers Association refi index that's down around 50 percent over the last nine weeks or so so it can be very interesting to see how these banks handle that and how they make comments in terms of what's what's gonna be the environment going forward it's very interesting so you're talking about mortgage banking fees that's on the income statements and that's gonna hurt profits I'm talking about the the balance sheet we're gonna have some hits to the balance sheet that's gonna hurt Book value is there any positives that we might see tomorrow I think so if you if you talk about the balance sheet the other thing I'll be watching is his loan demand are people borrowing rates went up and in order for these banks to benefit from rising rates they need to make loans at these higher rates and last quarter Mary Ann Lake the CFO of JPMorgan she said she was answering the question why is loan demand and loan growth low why is it so sluggish and she chalked it up to yes demands a little a little bit low but JP Morgan was also sitting on the sidelines a little bit because they weren't super comfortable making loans at record low rates so to be interesting to see what they say about that going forward did that were they more active as twin up and it also be interesting interesting to see is Wells Fargo or they in the same camp or their differing opinions about what is the future look for the loan environment between Wells Fargo and JP Morgan interest rate spreads that is the positive I'm gonna be looking for I think that spreads may have seen some benefit from this and that actually segues us into the next subject Freddie Mac a report from Freddie Mac this is a weekly report that shows the average conventional thirty-year mortgage rate continues to rise week over week continues to rise but the most marked rise we've seen is if we look at this on a year-over-year a basis the 30-year fixed mortgage is up almost a hundred basis points that is gigantic I mean if you're a homo or if you're homebuyer out there thinking about buying a home 100 basis points difference and how much you're gonna be paying on your 30-year fixed that's gigantic for the banks it could be a benefit one of the things that I've been looking at is that the difference in the movement between the 30-year fixed mortgage rate and actually some other lending interest rates versus the rates that banks are paying on CDs and on money market accounts CDs and money market accounts those aren't really going anywhere those rates aren't really moving yet they'll probably move at some point with all rates going up but we're seeing mortgage rates take off and it's within that spread that the bank's make their money it's the spread between what they're getting for what they're lending out and what they're paying to borrow and you know you look at a bank like Bank of America though it's got twice the amount of interest bearing deposits as non-interest bearing deposits obviously they're not paying anything I'm not interesting deposits so it doesn't matter so those interest bearing deposits the cost of those isn't really changing very much right now but what they're potentially getting on on loans and other securities that they're taking on their books is going up so this is good for Bank of America this is good for Wells Fargo and JP Morgan what I would I like about Bank of America a little bit more right now is that they lagged everybody else collecting the fees on mortgage origination so they're gonna see maybe a little bit less of a hit there where you look at Wells Fargo and JP they were killing it they were they were head and shoulders above everybody else way beyond Bank of America so they're gonna be hurting on that aspect this quarter Bank of America maybe not so much so so if the banks are benefiting from this wider spread collecting it on those longer-dated securities and loans and still not paying out a lot to the to their customers in those CDs money market accounts does that mean customers are losing people that are maybe in the mortgage in the in the market for a new home to get a mortgage are those people losing well losing is a you know I think a little bit of perspective is due here because we're you know we're in the mid 4% range for a 30-year fixed mortgage if we look back just five years if we look back ten years four and a half percent 30-year fixed mortgage would have been considered a dream you know so the what the problem is for for homebuyers is that if you compare that to the 3.5% that you get this time last year it looks terrible but but on a grander scale it's it's pretty good now the question is does that matter does it matter that in the in the bigger picture 4.5 percent is still a good rate maybe not you know that may impact demand that may hurt home builders you know home builders may see demands start to drop mortgage originators may continue to see demands start to drop because people are fixed on that 3.5% is a good rate 4.5% awesome yeah and I mean I'm in the camp that thinks it's not going to be a very good thing for consumers especially because since the crisis yes we've seen the stock market return to record highs but the average American their incomes aren't growing that that fast so they're still lagging behind especially when we see mortgage rates tick up and average Americans are still kind of stuck with where they are their income isn't isn't growing as quickly I think they stand to lose in that situation a little bit potentially so now thinking about the recovery from from the crisis and and whether banks are going to have to look for bailouts again are going to get hurt again we've got this issue of capital and yesterday on this show we were talking about new Federal Reserve it's it's a combo rule Federal Reserve Officer the Comptroller the currency and the FDIC all getting together it's a big party yes big party new rule higher capital ratios and you know what to some extent even even for us we follow this kind of stuff all the time for for bank analysts that are you know outside of these walls it's it's really difficult and tricky to navigate these risk weighted assets what is tier 1 capital versus tier 2 capital what's a leverage ratio versus versus just a regular tier 1 capital ratio it can make your head swim so I was looking at some numbers yesterday and I think a much simpler way for investors to look at this in terms of how well capitalized is the bank that I'm investing in is to simply take tangible equity and divide that by total assets now tangible equity of course if you look at that book value that the shareholders equity number and you deduct any non tangible assets on the balance sheet so non tangible assets that's goodwill and then often they label it really nicely for you and just say other intangible assets so you take both of those out of equity and then you you divide that tangible equity by total assets and you'll get to a percentage here's the interesting thing that I saw looking back to the end of 2007 I'm gonna rattle off a few names here remembering any particular name isn't as important as the big picture so Merrill Lynch that that that percentage was 2.2 percent Lehman Brothers 2.5% citigroup 2.7 percent bear stearns 2.9 percent Bank of America 3.2 percent in Wachovia 3.7 percent those all have something in common the median the median for that ratio that tangible equity to assets ratio in at the end of 2007 for the biggest banks was 4.6 percent so all of these banks were below the median and when we look at like I said Merrill at 2.2 percent and Lehman at 2.5% Citigroup down there Bank of America down there they're all well below the median and they all ran into big big troubles when when their capital was challenged on the other hand we look at JP Morgan and US Bancorp at the time we're at the median at 4.6 percent they saw far fewer problems as the other Wells Fargo at 5.9 percent well above the median Wells Fargo skated through and in fact dick kvass ovitch who was the CEO of Wells Fargo at the time argued vociferously against taking bailout money because Wells Fargo didn't need it right and and when you when you look at this ratio in comparison to everybody else you can see that Wells Fargo was far better capitalized BB&T another Bank 5.2 percent well above that median then what I did was I looked at today so what are the among the biggest banks today who is the best capitalized based on this ratio key Corp was way up there at the top at ten percent and I should say that the median when we think about banks changing between pre-crisis and today this is this is pretty telling the median of this ratio went from 4.6 percent in 2007 to 7.5% Club so across the board banks had become better capitalized but key corp 10 percent way up there Huntington Bank shares at eight point eight percent way up there Citigroup one of the best cap on this ratio one of the best capitalized banks at eight point five percent and then the other thing that I looked at is is the Delta so when we look at 2007 to today if we think about those banks that were you know potentially we can get Center under capitalized if they were below that median point in 2007 who made the biggest change Citigroup biggest change overall 5.8 percent Delta five point eight percent change PNC Bank made a big change Huntington Bank shares made a big change so again you know we hear all this about capital levels and and ratios and you know there there are a lot of calculations that we just can't do we can't do we can't sit here and do the risk weighted assets calculation that's going on at Bank of America but we can do is we can sit down and we can look at tangible equity versus assets and I think that this for shareholders for investors this is a pretty good measure to be able to look at how well capitalized the bank is without getting into those crazy numbers absolutely all right now after that moving on from that let's go to one of the big concerns this quarter for Bank earnings is mortgage fees right and we at JPMorgan and we look at Wells Fargo who lead the u.s. in mortgage origination we're expecting that their fee income is going to get hurt right because of the drop-off in mortgage originations but what exactly does this mean what what are we specifically talking about when we say the fee income from mortgages yeah so they say Wells Fargo and JP Morgan they both total it up to mortgage banking income but it's really really two distinct parts of what makes up mortgage banking income so if we think about walking in to your your mortgage broker going through the whole process getting the mortgage the bank will turn around and sell that mortgage typically to Fannie Mae or Freddie Mac who control roughly 90 percent of the mortgage market now so once they sell that off they record a gain on that sale of your mortgage but since once Fannie Mae takes that mortgage and they bundle it make it into mortgage backed securities they still need a bank and a servicer to service that mortgage and deal with the whole kind of the back-office function of dealing with that mortgage and we look at a bank like Wells Fargo I think their portfolio of what they service for for other investors and other people that hold those mortgages that they originated is almost two trillion dollars that's who that's that's who the end user who the who the mortgage the mortgage are is actually sending their payment correct so even if even if they Wells Fargo sells the mortgage to Fannie Mae you're not sending your mortgage payment to Fannie Mae you're still sending it to Wells Fargo and that's what they mean by servicing right and since they're servicing it they demand a fee from that from those investors who is ultimately getting the payment at the end of the day but Wells Fargo is kind of the middleman between the consumer you and I sending our payment to Wells Fargo and then they deal with the servicing so they get a fee from that they also get a fee from actually selling it to Fannie Mae or the other private entity if they decide to sell it off their books so those are the two main drivers of what that line will be when we see total mortgage banking income okay so not to get too wonky here but when we talk about that mortgage servicing in the way the bank's deal with that is it's not we get this fee income on an ongoing basis and that's what's running through our income statement and showing up on our profit line they actually take they assume well we're gonna get this expected stream of payments over the life of all these mortgages and they they discount it back to what they believe it's worth today and then that's an asset on the balance sheet and so the changes in mortgage rates and everything else and and the the income that they actually get that changes the value of the mortgage servicing rights portfolio and that's where it gets a little bit confusing so it's not mortgage servicing fees that they're recognizing it's changes in the value of this portfolio right so so again just to wrap up what you are saying we've got the fees for selling the selling mortgages that they originate on the one hand and then changes in the mortgage servicing rights portfolio right and I think if we as we've said already a couple times the mortgage origination fees those are almost certainly going to go down this corner the mortgage servicing rights portfolio however there's the potential based on how the bank's hedge that that that could actually show gains this quarter right and because when we think of that the mortgage servicing rights the main driver behind that is interest rates whether they go up and down and the second leg of that is people repaying their mortgages so if you and I prepay our mortgage and Wells Fargo is making income off of us and we prepay they don't get that income anymore so it changes the value of the of the rights there it's like you said the gains on the sales those will probably go down as activity goes down the other ones it's a little bit more of a juggling game between what are what are interest rates actually doing especially the second quarter they've been very volatile so it'll be very interested to see how has that changed at each of these banks okay finally looking ahead to tomorrow JPMorgan Wells Fargo reporting earnings let's let's put something on the line here Dave it's been a while but let's let's lay down a bet which stock do you think is going to perform better tomorrow in reaction to its earnings Wells Fargo or JPMorgan and let's put it let's put a Starbucks coffee on the line here none of your none of your fancy-schmancy stuff straight you lack common regular coffee just to be clear which which bank stock is going to perform better in reaction Terry's gonna go conservative gonna side with with mr. Buffett I'm gonna go with Wells Fargo yes there's concerns over the mortgage business says we've discussed extensively in the show today that is a concern but I really think Wells Fargo would they have the management team to manage through a volatile interest rate environment like we've seen a second quarter I think they've have a proven track record that they'll they'll hedge appropriately they'll scale back businesses when they need to so I'm putting my faith that Wells Fargo managed this and I think the market may be discounting that a little bit so I think Wells Fargo that stock is gonna trade higher than JP Morgan I'm actually I'm gonna go with JP Morgan not just because I have to because I want to JP Morgan has more capital markets exposure than Wells Fargo and I think as we look towards the the impact from the mortgage market this quarter I think that the the capital markets department at JP Morgan has a chance to offset some of that and with with the rising rates over the last quarter I mean it's been a pretty drastic rise I think maybe that could have could be additive there could have been some extra activity in the trading and in the trading group at JP Morgan which would produce more profits there in addition when I look at the valuation of JP Morgan today I don't I think that valuation takes in way too much pessimism really doesn't look at the value of JP Morgan the company today versus Wells Fargo which is which is valued considerably higher than JP Morgan so when I look at the two of them I think that there's more opportunity for investors to say hey JP Morgan is better than I thought it was versus Wells Fargo where they said I thought this was really great and maybe it's kind of falling short of my expectations we'll find out at four o'clock tomorrow for David Hanson I'm at copenhefer thanks for watching