Wall Street analysts taken an axe to profit forecasts for the biggest US banks, fearing that the US Federal Reserve – spooked by sluggish job growth and the UK vote to leave the European Union – will hold off on pushing up interest rates.
After the Fed’s first post-crisis bump in rates last December, many analysts had been counting on more increases to help boost bank earnings throughout this year and next.
But with JPMorgan Chase due to start the second-quarter reporting season this week, analysts now believe those assumptions look too bullish because of the market turmoil unleashed first by slumping oil prices and then the UK's referendum on EU membership.
Analysts at Credit Suisse have stripped out any expectation of higher rates from its estimates for US banks' profits in 2016 and 2017. Barclays and Morgan Stanley have also docked forecasts, noting that investors rate the chances of a rate rise from the Fed this year at about 20 per cent, down from about 75 per cent before the Brexit vote.
Just one of the big six US banks – Wells Fargo – is now expected to make a double-digit return on equity this year, according to consensus forecasts.
Even after a brighter US jobs report on Friday, benchmark bond yields barely moved from levels close to historic lows, said Ken Usdin, an analyst at Jefferies in New York. "We see macro-related downward [earnings] revisions driving the bus for a while," he said.
The muted outlook for the banks continues a general trend since the financial crisis, in which stubbornly low rates and much higher capital requirements have sapped returns for investors.
Second-quarter earnings are expected to be subdued, with drops in fees from trading and investment banking largely offsetting the benefits of a pick-up in fees from mortgage originations.
Analysts at Morgan Stanley expect year-on-year falls in quarterly earnings per share at Bank of America (-27 per cent), Citigroup (-23 per cent), JPMorgan Chase (-8 per cent) and Wells Fargo (-2 per cent). Only Goldman Sachs, which took a big litigation charge in the same period a year ago, is likely to see an increase.
Management teams will probably guide down expectations for full-year results, said Betsy Graseck, Morgan Stanley's lead analyst, in view of the "pessimistic" outlook for rates.
Interest rates drive banks’ profits in two main ways. If a bank can keep its cost of deposits steady, any move to push up overnight rates normally increases the spread on loans priced according to one-month or three-month Libor. Rising rates can also boost returns from banks’ securities portfolios – especially if the bank has shifted its mix to shorter-term assets that can be reinvested at higher yields.
But the big bond rally over the past few weeks means that banks’ net interest margins – the gap between the cost of funds and the yield on assets – will probably remain under pressure. In the first quarter, net interest margins rose a little, according to aggregate data from the Federal Deposit Insurance Corporation. But some analysts are braced for further compression as long as the Fed shies away from raising rates.
Jason Goldberg, lead analyst at Barclays in New York, expects the biggest banks to take "a harder line" on costs, while smaller banks may consider the more radical option of mergers.
"I think consolidation is a secular trend," he said. "The number of banks [in the US] halved in the last 20 years, and they'll halve again in the next 20." – Copyright The Financial Times Limited 2016
