Fed Cut Clouds Banks' Earnings Outlook, Are Lenders Worried? (Revised)

On Jul 31, Federal Reserve Chairman Jerome Powell announced the widely anticipated quarter-point rate cut. The central bank said that the reduction was necessary to counter a sluggish global economy and under-par inflation. However, Powell described the rate cut as a “midcycle adjustment” and does not foresee any economic weakness that would require a full-fledged rate-cutting cycle.

But for banks, rate cut clouds the future earnings outlook. Lower rates will weigh on margins, reducing the possibility of future profits. In fact, big banks like JPMorgan Chase & Co. JPM and Goldman Sachs Group Inc. GS have already reduced their projections for the upcoming quarters till 2020.

Factors That Boosted Earnings in Q2

U.S. banks’ second-quarter earnings were boosted mainly by American consumers who preferred “using credit cards more than debit.” High spending power and low interest rates led them to utilize credit facilities for purchasing all durables and non-durables.

The second quarter was profitable for all major banks of Wall Street. JPMorgan topped the list with a 3.6% EPS beat. Citigroup, Wells Fargo Corp. WFC and Bank of America Corp. BAC surpassed their respective estimates owing to a credit surge and higher consumer banking revenues.

As of Jul 31, 74.5% of companies in the Finance sector has reported earnings, of which banks are majority participants. The estimated Q2 earnings growth from the sector is 5.9% on 7.2% revenues growth. As of Jul 31, earnings have increased by 4.5% and revenues by 3.8%. Though Q2 revenues are expected to fall from Q1, earnings growth should be substantially higher. In Q1, earnings growth came at 2.7% on 8% revenue growth.

Retail banking fueled earnings during the second quarter more as stronger borrowing boosted revenues and profits. JPMorgan reported that card spending has increased 11% to $192.5 billion. Whereas Wells Fargo reported a 6% increase.

Additionally, the average rate for 30-year, fixed-rate mortgage has fallen below 4%, improving demand for purchase and refinancing homes driven by mortgage originations for JPMorgan, Wells Fargo and Citigroup Inc. C .

A standalone event, which improved profits for JPMorgan, Citigroup, Wells Fargo and Goldman Sachs, was the IPO of the electronic trading platform Tradeweb Markets Inc. TW .

Majorbanks including Citi, JPMorgan, Wells Fargo, Bank of America and Goldman Sachs have gained 36.7%, 18.8%, 51.%, 24.5%  and 31.7%, respectively, on a year-to-date basis. Each of these stocks has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank stocks here.

Outlook Clouded?

A quarter point rate cut with no expectations of further cuts in the near future has dampened the market’s sentiment, true. But this has not cleared the cloud on banks’ outlook. Banks generate income from the gap between interest paid on deposits and charged to lenders. Though Fed's string of rate hikes had boosted banks’ income, rate cuts will definitely dampen it.

Bank of America had earlier projected net income rise of 3% in 2019 but now only 1% rise is likely if Fed decides to cut rates twice this year.

According to JPMorgan’s CFO Jennifer Piepszak, if the Fed simply trims rate for once this year, net interest income for the bank will be more than $57.5 billion.

Other giants in the sector, Citi and Wells Fargo have already accelerated in plans for cost-cutting to cope with potential headwinds. As a precautionary measure big banks have ramped up share buybacks, which shrink share count and boost per-share profits.

Conclusion

While the Fed Chair believes that an extended period of monetary easing is unlikely, another rate cut later this year is widely predicted. Given this backdrop, a lot will depend on the individual operational efficiency of banks when it comes to future earnings.

(We are reissuing this article to correct a mistake. The original article, issued on August 1, 2019, should no longer be relied upon.)

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