As the third quarter earnings season begins, all eyes are on JPMorgan Chase and Wells Fargo, the first of the big banks set to report their earnings on Friday. Investors are keenly focused on how these financial giants will forecast their future net interest income (NII) amidst a backdrop of fluctuating Federal Reserve rate expectations and a sluggish lending environment. With the Fed’s next steps on interest rates unclear, the broader banking sector’s outlook has become a major point of concern, particularly after a surprisingly strong September jobs report muddied expectations for rate cuts in the coming months.
Both JPMorgan Chase and Wells Fargo are expected to report lower profits for the third quarter of 2024, with analysts pointing to shrinking NII as a key factor. NII, the difference between what banks earn on loans and what they pay out in deposits, had been a source of immense profitability for the sector in recent years. As the Fed raised interest rates aggressively to combat inflation, the gap between loan yields and deposit costs widened, leading to a windfall for banks. However, the tide appears to be turning.
“Weak loan growth, higher deposits, and increasing loan loss provisions due to a rising unemployment rate — all of this will result in pressure on margins and will moderately bring NII down,” noted Stephen Biggar, a banking analyst at Argus Research.
The question now is whether any potential Fed rate cuts could significantly impact NII. While lower rates would reduce what banks can earn on loans, they could also spur more borrowing and dealmaking, potentially offsetting some of the declines in interest income.
Economists have mixed views on the path of Federal Reserve rate cuts, particularly after the strong jobs report in September raised the possibility that the Fed might hold off on cutting rates in the near term. Betsy Graseck, a banking analyst at Morgan Stanley, has outlined a scenario in which the Fed could cut rates by 150 basis points by mid-2025. This expectation is based on the notion that the U.S. economy might avoid a recession, despite ongoing inflationary pressures and rising unemployment.
“In this environment, investor focus is likely to shift quickly to forward outlooks rather than current results,” Graseck said in a recent report.
For big banks like JPMorgan Chase and Wells Fargo, the potential for future rate cuts is a double-edged sword. On one hand, lower rates mean smaller interest payments on loans, squeezing profits. On the other, a lower rate environment could boost loan demand, encouraging businesses to borrow and consumers to refinance. The balance of these factors will be critical for banks’ financial health going forward.
One area where banks might find some relief is in their investment banking divisions, which analysts expect to have seen a modest uptick in activity during the third quarter. Debt issuance, equity follow-on offerings, and initial public offerings (IPOs) all saw increased volumes, particularly as market participants adjusted to the current rate environment.
Oppenheimer & Co. has forecasted an average of a 7% rise in investment banking revenues across major banks, a solid increase but still short of the pre-pandemic highs. “While the investment banking rebound is welcome, it hasn’t quite reached the levels we were used to in 2021 or early 2022,” said Chris Marinac, director of research at Janney Montgomery Scott.
Still, the outlook for mergers and acquisitions (M&A) remains tepid. Companies have been reluctant to engage in large-scale deals amidst economic uncertainty and fluctuating market conditions. Analysts expect M&A activity to stay muted until there’s more clarity around the Fed’s future rate moves and broader economic trends.
The banks’ trading divisions are another area where third-quarter performance may have been buoyed by market volatility. Heightened uncertainty around inflation, interest rates, and geopolitical tensions led to a resurgence in market fluctuations, which typically provides opportunities for trading profits.
However, analysts at Moody’s caution that despite this uptick in volatility, overall trading revenues may still see a decline compared to the second quarter. “The third quarter is typically a seasonal slowdown in trading, and we expect that to be reflected in the results, despite the choppiness in the markets,” the Moody’s report noted.
In recent years, one of the most persistent concerns for the banking sector has been the health of the loan portfolios, particularly in areas like office real estate loans. The slowdown in commercial real estate has been well-documented, but analysts believe that banks have already accounted for many of these risks by setting aside large reserves to cover potential losses.
Moreover, consumer loan delinquencies, which spiked after the banking crisis last year, have started to plateau as banks have tightened underwriting standards. Some banks have reported lower demand for new consumer loans, but this has been partially offset by healthier credit quality in existing portfolios.
Despite these improvements, provisions for loan losses are expected to increase in the third quarter, particularly as unemployment rates continue to rise. “While credit quality should remain healthy, loan loss reserve builds for credit card growth should also dampen earnings momentum,” said Saul Martinez, a banking analyst at HSBC.
- JPMorgan Chase
JPMorgan Chase, the largest U.S. lender by assets, is expected to report an 8% year-over-year drop in its earnings per share (EPS), according to estimates compiled by LSEG. This decline is largely attributed to shrinking NII as the gap between loan yields and deposit costs narrows. The bank’s loan growth has also remained relatively subdued, adding to the pressure on its profitability. Despite this, JPMorgan remains well-positioned in terms of capital and liquidity, and analysts believe that its investment banking and trading divisions could provide a buffer to offset some of the NII-related challenges. - Wells Fargo
Wells Fargo’s earnings are similarly expected to take a hit, with analysts forecasting a nearly 14% drop in EPS. Like JPMorgan, Wells Fargo has seen its NII pressured by shrinking margins on loans and deposits. In addition, the bank is still grappling with regulatory issues stemming from its various scandals in recent years. Last month, the bank received another rebuke from regulators, and its executives will likely face tough questions about its progress in addressing these concerns. On the positive side, Wells Fargo’s investment banking division may have seen a boost in activity, and its loan loss provisions are expected to remain manageable, thanks to conservative underwriting practices. - Bank of America
Bank of America, which reports its earnings on October 15, is also expected to see a significant decline in EPS, with estimates pointing to a 14% drop year-over-year. Analysts believe the bank’s NII will continue to be under pressure, and its investment banking gains are expected to be more modest compared to some of its peers. Bank of America’s management has indicated that they do not expect a major rebound in trading revenue either, adding to the challenges facing the institution. - Citigroup
Citigroup is projected to report a nearly 20% drop in EPS for the third quarter, making it one of the worst-performing major banks in terms of profitability. The bank’s revenue growth has remained tepid, and it has been forced to set aside additional provisions to cover potential loan losses. Analysts also expect trading income to decline as market conditions remain challenging for the firm. Furthermore, Citigroup continues to deal with compliance issues, having been fined $136 million in July for regulatory infractions. Investors will be closely watching how the bank addresses these concerns during its earnings call. - Goldman Sachs and Morgan Stanley
Goldman Sachs and Morgan Stanley, both of which report their earnings later in the month, are expected to fare better than their peers on the strength of their investment banking and capital markets activities. Goldman Sachs is forecast to see a 35% jump in EPS, driven by improvements in investment banking, while Morgan Stanley’s EPS is expected to rise by 14%, thanks to strong performance in equity and capital markets. Chris Marinac of Janney Montgomery Scott pointed out that limited compensation growth at both banks could also provide some operating leverage, boosting earnings even further.
