Big U.S. lenders are stockpiling reserves for potentially bad loans, and sinking profits in the process
Second-quarter results for the biggest U.S. banks won’t be pretty.
The novel coronavirus has wreaked havoc on the economy—and the banks’ operations. Lending money has become a much riskier proposal, forcing banks to put aside billions of additional dollars in case consumers and businesses stop paying. And early this year, the Federal Reserve cut interest rates, which was meant to shore up the economy but also lowered the margin banks can make on any lending they do.
“When we look at our earnings, last quarter was obviously quite weak. You’ll see the same thing this quarter,” Charles Scharf, chief executive of Wells Fargo & Co., said in late May.
His is the only big bank expected to swing to a loss in the latest quarter, according to analysts polled by FactSet.
Others are expected to remain profitable but see big declines. JPMorgan Chase & Co. and Citigroup Inc., which will both report Tuesday alongside Wells Fargo, are forecast to post at least 60% drops in income from a year ago.
The concern has shown in bank stocks, which have lagged behind a surging market rally over the past three months. The KBW Nasdaq Bank Index is down 35% this year, while the S&P 500 is down just 1.4%.
The biggest hit to earnings will be loan-loss provisions, money the banks set aside for potentially souring loans.
Analysts were caught off guard in April when the banks said they were setting aside billions of extra dollars for potential losses, hammering their first-quarter earnings.
The unprecedented nature of the pandemic and the banks’ continuing efforts to help consumers have analysts unsure what to expect for the second quarter. Many lenders are letting customers temporarily skip payments, hoping that will buy time for the economy to recover and for borrowers to get back on track. But many analysts are expecting delinquencies to soar later this year as the pandemic drags on.
“We believe that the cadence is full of guesswork,” Jefferies analyst Ken Usdin wrote. Still, he ventured the figures would be “eye-popping.”
Several banking executives said they expected to set aside more money for bad loans in the second quarter than they did in the first. “I would tell you that we currently expect to see a higher level of reserves in the second quarter,” Citigroup’s finance chief, Mark Mason, said in June.
Executives caveated that the changing tides of the pandemic and economic shutdown made it hard to know. The national unemployment figure has been better than many expected and some states have begun reopening, raising hopes the worst fears were overdone.
A bright spot will be investment banking and trading.
In the first quarter, revenue from investment banking, fixed-income trading and equities trading hit a five-year high, according to data provider Coalition. Executives have said the second quarter was doing even better.
In late May, JPMorgan’s investment banking boss, Daniel Pinto, said he was expecting markets revenue to rise about 50% from last year’s quarter, a forecast that would imply a $2.5 billion increase.
The constricting combination of lower interest rates, higher deposits and slowing loan growth is squeezing bank margins.
Banks make money by charging borrowers more interest than they pay depositors. In the first quarter, the industry’s net-interest margin fell to the lowest point since 2016, according to the Federal Deposit Insurance Corp.
Analysts said the second quarter will be worse, partly because the Fed’s recent rate cuts were in March, affecting only the end of the first quarter.
Customers of all sizes continued parking more cash at the banks throughout the second quarter. Total deposits at U.S. banks are up more than $2 trillion this year, according to weekly data from the Fed. That is by several multiples the biggest six-month increase on record.
The banks haven’t been able to lend out that money in the pandemic for a profit.
DIVIDENDS AND BUYBACKS
The quarter will be missing one sizable lift: stock buybacks.
Seeking to preserve capital, the big banks halted share repurchases in March and the Fed later ruled out any repurchases through the third quarter. That means per-share earnings won’t be boosted by reduced share counts.
In addition, the Fed put some restraints on dividends, ruling the payouts couldn’t exceed the average earnings of the past four quarters. That forced Wells Fargo to say it would cut its dividend. Other banks held steady, but the change will put income in a greater spotlight.
Analysts warn that earnings surprises now could lead to bigger stock reactions given the increased ties between earnings and dividends.