US banks are preparing investors for a prolonged period in which low interest rates are a drag on their profits.
Speaking at an industry conference last week, most of the nation’s biggest banks — including JPMorgan Chase, Wells Fargo, Citigroup, and Bank of America — trimmed their forecasts for net lending revenues for 2020, attributing the cuts to sustained low rates as well as waves of homeowners refinancing their mortgages at lower rates.
JPMorgan, for example, cut its net interest income forecast by $1bn, to $55bn — as compared to $57bn in 2019.
The US Federal Reserve projected last week that rates would remain at their current rock-bottom level until at least 2023, and that it would not tighten policy without first seeing a sustained period of inflation. This is bad news for banks’ profit margins, as low interest rates depress loan yields and the cost of deposit funding cannot fall much further.
Worries about the impact of low rates drowned out more encouraging news delivered in the banks’ updates. Most said that reserves for credit losses, after big increases in the first two quarters of the year, were unlikely to rise in the third, given solid credit performance. Almost every bank reported that the number of borrowers taking advantage of payment holidays continued to fall.
“We set our second-quarter reserves with a set of scenarios [and it] turned out that the actual data has been better . . . charge-offs keep coming down, frankly, because of credit quality,” said Bank of America chief executive Brian Moynihan. Wells Fargo chief financial officer John Shrewsberry noted that in commercial lending “we’ve actually seen some better realised outcomes than we imagined”. Many other executives echoed that theme.
Banks’ provisions for bad loans have risen by $111bn this year, to $223bn, close to the peak levels of the financial crisis, according to the Fed.
“The group is going down two different tracks — credit and rates,” summed up Scott Siefers, bank analyst at Sandler O’Neill. While the rate environment is a drag, “the credit updates have been about as good as can be hoped. The big reserves are done, at least for now. The [loan payment] deferral updates were constructive too.” Mr Siefers said the emerging consensus on Wall Street was that this would be a “confined” credit cycle, with certain industries hit hard, but most performing reasonably well.
Another piece of good news: banks’ capital markets operations have continued to benefit from higher activity. Both JPMorgan, Citi and BofA for example, project double-digit year-over-year increases in trading revenues for the third quarter.
Yet markets continue to focus resolutely on the bad news. Banks’ stocks have underperformed the wider market by 30 per cent since the Covid-19 crisis began and trade at whopping valuation discounts. The S&P 500 now has a price/earnings multiple of 24; many banks trade at 10 to 12 times earnings.
The low expectations continue into next year: analysts’ estimates for the large banks’ earnings per share in 2021 have not recovered at all from the lows they hit a few months ago, and are a third or more below where they were in February.
The pervasive pessimism has left bank investors scratching their heads. Eric Hagemann, of Pzena Investment Management — which manages $35bn and has substantial positions in banks including JPMorgan, Citi and Wells Fargo — said that banks’ widening discount made little sense, given that low interest rates should support all stock valuations, by lowering the discount rate for future profits.
“Banks are underperforming because of low rates, but low rates should increase the multiple of all equities. Earnings-per-share estimates coming down makes sense — but multiple contraction, too? It seems like double punishment.” He also noted the potential for some banks’ heavy provisions for bad loans being released as the crisis abates. “If there are reserve releases, the earnings numbers these guys are going to put are going to be huge,” he said.