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BANK OF AMERICA

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As Banks Report Earnings, Fed Looks to Take Away the Punch Bowl

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07/14/2019 | 12:15pm EDT

By Telis Demos

What goes up must come down.

Rising interest rates have boosted bank earnings for several years, but those days are over. Federal Reserve Chairman Jerome Powell signaled recently that the central bank is ready to cut rates.

Big banks start reporting second-quarter earnings Monday, and investors will be closely watching for signs of how much the Fed's change in rate policy could hurt the banking business.

Banks make money by charging more on loans than what they pay on deposits. This net interest margin is a core measure of profitability.

When the Fed began raising rates in late 2015, net interest margin grew as banks repriced loans faster than depositors demanded more interest. A boom in bank earnings followed.

That long expansion came to an end this year after the Fed signaled it would pause rate increases because of concern about an economic slowdown. That made it harder for banks to raise their loan rates, but consumers and companies continued to demand higher and higher deposit rates, putting a squeeze on banks.

The question is how much margins could fall. Some banks have taken defensive measures that could blunt the impact of the rate pause. Ally Financial Inc. and Goldman Sachs Group Inc. recently lowered the rates they pay on online savings deposit accounts.

Another driver of profit narrowing for banks is the increasingly small difference between long- and short-term interest rates.

Banks generally borrow at lower, short-term rates and lend at higher, long-term rates. But as the rate curve flattened, meaning those rates converged, it became harder for banks to make money. Flat curves are also typically an indication that investors expect the economy to slow, which would be bad news for banks.

One thing working in banks' favor has been that borrowers have remained healthy. The rate at which banks have written off bad loans for nonpayment has inched higher over the past few years. But it remains at a historically low level despite some economists' concern that consumers and companies have too much debt relative to the strength of the economy.

Bank stocks haven't kept up with the broader market's surge over the past year. In addition to worries about rates, investors are concerned that banks' trading revenue will sag for a third straight quarter.

Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. all said during the course of the second quarter that their trading revenue was on track to fall in the second quarter from a year earlier. Though stocks are surging, bankers say their clients have remained cautious and are spooked by political issues such as the U.S.'s trade disputes with China and Mexico. As a result, banks say, clients aren't paying them to put on big new bets.

Also, banks' net income will grow more slowly than it did last year, when the benefits of a 2017 corporate tax cut came into effect.

Citigroup kicks off the major banks' quarterly earnings reports on Monday, followed by Goldman Sachs, JPMorgan and Wells Fargo & Co. on Tuesday; Bank of America on Wednesday; and Morgan Stanley on Thursday.

Write to Telis Demos at telis.demos@wsj.com

Stocks mentioned in the article
ChangeLast1st jan.
ALLY FINANCIAL INC -0.79% 31.45 Delayed Quote.38.79%
BANK OF AMERICA 0.69% 29.19 Delayed Quote.17.65%
CITIGROUP INC. -0.70% 70.82 Delayed Quote.36.04%
GOLDMAN SACHS GROUP INC -1.03% 213.3 Delayed Quote.27.69%
JP MORGAN CHASE & COMPANY -0.98% 113.99 Delayed Quote.17.93%
MORGAN STANLEY -1.49% 43.77 Delayed Quote.10.39%
WELLS FARGO & COMPANY -0.20% 45.21 Delayed Quote.-1.69%
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Financials (USD)
Sales 2019 92 254 M
EBIT 2019 38 862 M
Net income 2019 27 191 M
Debt 2019 -
Yield 2019 2,28%
P/E ratio 2019 10,2x
P/E ratio 2020 9,46x
Capi. / Sales2019 2,96x
Capi. / Sales2020 2,92x
Capitalization 273 B
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Mean consensus OUTPERFORM
Number of Analysts 29
Average target price 32,75  $
Last Close Price 29,19  $
Spread / Highest target 47,3%
Spread / Average Target 12,2%
Spread / Lowest Target -4,08%
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Brian T. Moynihan Chairman, President & Chief Executive Officer
Catherine P. Bessant President-Global Product Solutions & CMO
Thomas Kell Montag Co-Chief Operating Officer
Paul M. Donofrio Chief Financial Officer
Thomas J. May Independent Director
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WELLS FARGO & COMPANY-1.69%211 863
CHINA CONSTRUCTION BANK CORPORATION12.72%200 723
HSBC HOLDINGS PLC2.69%168 727