U.S. banks lower expectations in era of low interest rates

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US banks are preparing investors for a prolonged period in which low interest rates weigh on their profits.

Speaking at an industry conference last week, most of the nation’s largest banks – including JPMorgan Chase, Wells Fargo, Citigroup and Bank of America – have cut their net loan income forecasts for 2020 , attributing the cuts to sustained low rates as well as waves. of homeowners refinance their mortgages at lower rates.

JPMorgan, for example, cut its forecast for net interest income by $ 1 billion, to $ 55 billion – from $ 57 billion in 2019.

The US Federal Reserve projected last week that rates would stay at their current low until at least 2023 and that it would not tighten policy without first experiencing a period of sustained inflation. This is bad news for banks’ profit margins, as low interest rates lower loan yields and the cost of deposit financing cannot fall any further.

Concerns about the impact of low rates drowned out more encouraging news delivered in bank updates. Most said credit loss reserves, after sharp increases in the first two quarters of the year, were unlikely to increase in the third, given the strong credit performance. Almost all banks reported that the number of borrowers taking advantage of payment holidays continued to decline.

“We established our second quarter reserves with a set of scenarios [and it] turned out that the actual data was better. . . write-offs continue to decline, frankly, because of the credit quality, ”said Bank of America CEO Brian Moynihan. Wells Fargo CFO John Shrewsberry noted that in the area of ​​commercial lending, “we’ve actually seen better results than we ever imagined.” Many other leaders echoed this theme.

Banks’ provisions for bad debts increased by $ 111 billion this year, to reach $ 223 billion, near financial crisis highs, according to the Fed.

“The group takes two different paths – credit and rates,” summarizes Scott Siefers, banking analyst at Sandler O’Neill. Although the rate environment is a drag, “credit updates have been about as good as we could hope for. The big reservations are over, at least for now. the [loan payment] The postponement updates were also constructive. Mr Siefers said the emerging consensus on Wall Street was that it would be a “confined” credit cycle, with some industries hit hard, but most performing reasonably well.

More good news: Banks’ operations in capital markets continued to benefit from increased activity. JPMorgan, Citi and BofA, for example, are forecasting double-digit year-over-year increases in trading revenue for the third quarter.

Yet the markets continue to focus resolutely on the bad news. Bank stocks have underperformed the market as a whole by 30% since the start of the Covid-19 crisis and are trading at huge valuation discounts. The S&P 500 now has a price / earnings multiple of 24; many banks trade between 10 and 12 times their profits.

Low expectations continue into the next year: Analysts ‘estimates for big banks’ earnings per share in 2021 have not recovered at all from the low they reached a few months ago, and are a third or more below their February level.

The pervasive pessimism has left bank investors scratching their heads. Eric Hagemann of Pzena Investment Management – which manages $ 35 billion and has substantial positions in banks such as JPMorgan, Citi and Wells Fargo – said the widening of the banks’ haircut made no sense, being given that low interest rates should support all stock valuations, lowering the discount rate for future earnings.

“Banks are underperforming due to low rates, but low rates should increase the multiple of all stocks. Falling earnings per share estimates make sense – but so does multiple contraction? It looks like a double punishment. He also noted the potential for some banks to release heavy provisions for bad loans as the crisis eases. “If there are any reserve releases, the profit numbers that these guys are going to put in will be huge,” he said.

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