Bank earnings may reveal ugly-looking loan portfolios for the second quarter, but the industry hopes to defend its investment banking and cost-cutting efforts to squeeze earnings.
The earnings season will kick off on Tuesday when JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC) report earnings before the market bell, covering the performance of the major US banks during the three-month period ending the June 30th.
“The next [second quarter] the earnings will be confusing, sloppy and shocking for some banks, “wrote RBC’s Gerard Cassidy on July 11.” But our outlook is cautiously optimistic as we expect the economy to continue to gain momentum by the end of the year. “
Profit growth at big banks is likely to be hampered by dramatic increases in loan loss reserves as trade struggles and job losses hurt loan payments across the United States economy.
Lower interest rates have also compressed banks’ profitability, as Federal Reserve rate cuts have spurred lower interest rates in both the short and long term.
KBW banking analyst Brian Kleinhanzl expects bank earnings to drop 24.9% year-over-year for the midsize bank this quarter.
“[T]There are still open questions about the maximum amount of credit losses that will be borne by banks, and until there is more certainty about it, we believe it will be difficult for banks to outperform the market, ”wrote Kleinhanzl on July 1.
The banking industry has had a difficult 2020 relative to the overall market, suffering steeper losses during the tumultuous market crash in late March and a warmer rebound in the following months.
As of Monday afternoon, the KBW Nasdaq Bank (^ BKX) index is down more than 34% so far this year. Meanwhile, the S&P 500 has effectively recouped its losses and is now down only 1.5% so far this year.
As banks prepare for larger loan losses through those accumulations of reserves, big American banks with diversified income streams can look beyond the loan books to make money.
KBW and RBC noted that companies with large investment banking divisions are poised for success in the second quarter, specifically highlighting JPMorgan Chase, Goldman Sachs (GS) and Morgan Stanley (MS).
Capital markets were likely helped during the second quarter by Federal Reserve liquidity interventions in various markets (such as municipal debt, corporate debt, US Treasury bonds, US dollar funds) that restored confidence among market makers like big investment banks.
“We expect very strong business results this quarter, as credit spreads have compressed, supply and demand spreads remain wide, and business activity remains high,” wrote Kleinhanzl.
At RBC, Cassidy expects investment banking revenues to rise 6.8% year-on-year among the largest banks in the US, driven by higher gains specifically in the debt capital markets.
Banks can also highlight cost reduction on their earnings. Some banks are already cutting staff; Bloomberg reported last week that Wells Fargo is planning thousands of job cuts.
However, the San Francisco-based bank has faced reputational and regulatory challenges in recent years and is likely to be the only major bank to announce a dividend cut in earnings this week. Due to COVID-19 disruptions, the Federal Reserve has banned the largest banks in the US from repurchasing shares for at least the third quarter, although banks can still pay dividends.
But secular trends in the banking industry have pointed to a downsizing long before the arrival of COVID-19. Wells Fargo banking analyst Mike Mayo predicted that the automation and growth of mobile banking will lead to 200,000 job cuts in the next 10 years.
