Banks have made it through another quarter in the always uncertain and chaotic coronavirus pandemic. After two intense quarters, I think most analysts expect the third quarter to bring stronger results. America's two largest banks, JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC), are expected to report $2.06 and $0.44 in earnings per share, respectively, according to Yahoo! Finance. Both of those estimates, if correct, would top the two banks' quarterly profits from earlier this year -- but not their totals from the third quarter of 2019.
Here are five things you can expect to see when banks begin to report third-quarter results next week.
1. Lower net interest income
Banks' quarterly revenue is expected to drop as a result of the Federal Reserve lowering its benchmark lending rate from 2% to zero in March. That was an abrupt move, so there is a lag effect on banks. The new low-rate environment will have the largest impact on net interest income, which is the difference between what banks make on their interest-bearing assets (loans and securities) and what they pay on their interest-bearing liabilities (deposits). When the Fed drops its benchmark rate, interest payments on assets such as loans with a variable interest rate drop with it to an extent, resulting in less money for the bank.
At the Barclays Global Financial Services Conference in September, Bank of America CEO Brian Moynihan said he expects to see net interest income drop by $600 million or $700 million in the third quarter. JPMorgan Chase CFO Jennifer Piepszak revised the bank's net interest income down from $56 billion to $55 billion for the year.
2. Minimal credit provisions
The big pain point in bank earnings reports this year has been the high provisions the industry has had to take to prepare for potential loan losses brought on by the pandemic. This has been magnified by the new current expected credit losses (CECL) accounting method that banks started operating under this year. CECL requires banks to project out losses on loans as soon as those loans hit the balance sheet. As a result, many banks increased their total reserves to cover loan losses in addition to everything they had to add for the pandemic.
The good news is CECL typically has banks front-loading their provisions, so after two quarters of heavy provisioning, most banks have accounted for the bulk of the potential losses in their current loan books and should see a more muted provision in the third quarter. At the Barclays conference, Piepszak said she expects to see "near zero" in terms of a reserve build for JPMorgan. Moynihan said the reserve build would be "very modest," if anything at all. The outlooks did not seem quite as promising for Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C), but both seemed to think that any reserve build would be meaningfully lower than the previous two quarters.
Although the third quarter looks good, one thing to keep in mind is that banks may still need to build reserves again depending on what happens with the pandemic over the winter, and how it impacts the economy.
3. Strong (but lower) investment banking revenue
Investment banks are coming off one of their best performances in the second quarter, when revenue soared due to banks helping lots of companies with debt and stock issuances. Investment bank divisions should continue to perform well, although perhaps not as well as in the second quarter. Piepszak estimated JPMorgan's markets business revenue will be up about 20% year over year in the third quarter, with investment banking fees up mid- to single-digits from the third quarter of 2019. Moynihan said he expects trading revenue at Bank of America to be up 5% to 10% year over year in the third quarter.
4. Still waiting on actual losses
When recessions occur, banks set aside money to cover loan losses; borrowers become delinquent on their loan payments, and banks eventually must charge off the loans because the debt is unlikely to be collected. But during the pandemic, the timeline regarding this series of events has been drastically pushed out. In regards to actual losses and delinquencies, Piepszak said, "We're not seeing anything that you would typically expect to see at this point in a recession." Moynihan said charge-offs are coming down at Bank of America, while Citigroup CFO Mark Mason recently said, "We are not seeing material signs of stress for the U.S. consumer." Most banks do expect losses to materialize, but not until 2021.
A big part of this story is government intervention. The Paycheck Protection Program, unemployment assistance, stimulus checks, and funds for the hardest-hit industries have helped keep borrowers on their feet. A new stimulus bill, if it materializes, would be a huge help for banks on the credit quality side.
5. Loan deferrals on the decline
We know based on updates from many banks -- both large and small -- that deferrals are on the decline. The questions now are: Will they have come down further when banks provide an update? How long will the remaining deferrals last? And can banks ultimately make a decision on the credit quality of these borrowers? Moynihan has said that after this quarter, "You won't see anything about deferrals other than some discussion about the mortgage, because the rest of it's irrelevant. It's either in the delinquencies or not at this point." I'll be interested to see which banks follow suit and which still have a decent amount of deferrals left on their books. Hopefully, updates will be able to provide some clarity for investors who have been scared away by all the uncertainty surrounding credit quality.