US banks the canaries in the earnings coal mine

Company News

by Glenn Dyer

Second quarter profits at America’s biggest banks are expected to fall sharply from a year earlier when they start reporting over the next few days.

The big six US banks kick off the June quarter earnings season on Thursday, Friday and next Monday and are expected to provide a template for many of the companies in the S&P 500 reporting for the June quarter, as well as the performance of banks globally.

In many cases big write downs, loan loss provisions and revenue weakness will both highlight the growing fissures in corporate activity, as well as hiding some of the underlying strength – such as in energy.

 According to US analysts, banks face increased loan loss reserves (especially in the wake of the recent Federal Reserve Stress Tests on big US banks), as the pandemic rebound merges into the growing possibility of a possible recession.

Analysts expect JPMorgan Chase will report a 25% drop in June quarter profit on Thursday, while Citigroup and Wells Fargo will show 38% and 42% profit declines, respectively on Friday.

Morgan Stanley, a major Wall Street player and investment manager, also reports on Thursday and is expected to show a 17% decline in earnings.

Goldman Sachs Group reports on Monday and is forecast to report a 51% profit drop because of weak trading and investment revenues and earnings.

Bank of America Corp, which like its peers has big consumer and business lending franchises, is expected to show a 29% drop in profit when it also reports next Monday.

While JPMorgan, Citi and Bank of America will be strengthening their 1% stress buffers after the stress tests raised questions about their adequacy, analysts expect them and other banks to top up their general provisions against future losses as interest rate rises and fears of a recession grow.

This alone will have a negative impact on earnings compared to the June, 2021 quarter when the banks benefited from lower as anticipated pandemic losses failed to happen and the economy strengthened. Many banks wrote back some of their big 2020 provisions in 2021 which in turn boosted earnings, dividends and buybacks.

This year it is going to be a very different story. As Jason Ware, chief investment officer for Albion Financial Group, told Reuters, “It’s going to be a shaky quarter for the sector.”

Banks must factor the economic outlook into loan loss reserves under a change to the way they provide for bad debts (more prospectively rather than after the event) in an accounting standard which took effect in January 2020.

JPMorgan CEO Jamie Dimon warned last month of an economic “hurricane,” while Morgan Stanley CEO James Gorman has said there is a 50% chance of a recession.

“The banks are going to have to build up their reserves,” said Gerard Cassidy, a bank analyst at RBC Capital Markets said this week.

JPMorgan, Citi, Wells Fargo and Bank of America, the country’s largest four lenders, could boost their loan loss provisions by $US3.5 billion compared with $6.2 billion from write backs last year when they released reserves.

As a result, the banks’ bottom lines will look worse than their underlying businesses. Pre-provision, pre-tax profits for the big four will be down only 7%, according to analysts at Barclays.

While actual loan losses and delinquency rates are still near record lows, the sharp rise in interest rates from the Fed will prompt a rise in provisioning against more bad debts in 2023. That’s despite the still strong labour market.

Banks will also benefit from rising interest payments from customers than to the Fed – with more to come. Net interest income rose 14% in the second quarter, on average, for the four biggest banks.

But a recession could choke off those gains.

Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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