By Chris Dorrell
US earnings season kicks off later this week with a string of results from some of the country’s largest banks.
JP Morgan, Citi Group, Wells Fargo and Bank of America will all release results on Friday in an interesting environment – to say the least.
While higher interest rates have led to record levels of net interest margin – the difference between what banks receive from borrowers and what they pay out to depositors – banks are expected to have to increase their loss provisions as the economy enters recession.
It is still likely that the banks will deliver strong results, with the tailwind from higher interest rates blowing stronger than the headwind stemming from loss provisions. How long that will remain the case into 2023 is the big question.
Bank of America’s net interest margin increased to 2.1 per cent in the third quarter of 2022, up from 1.7 per cent in the same period last year. Citigroup’s net interest margin rose to 2.3 per cent from 1.9 per cent while Wells Fargo increased to 2.8 per cent from 2.0 per cent.
JP Morgan recorded a smaller increase, to 1.8 per cent in the third quarter of 2022 from 1.6 per cent.
With interest rates expected to peak and possibly fall in 2023, these margins will likely decrease over the year.
Yet even with 2022’s higher interest rates, earnings, though they remain very strong, have actually fallen from last year as the banks were forced to increase their loan loss provisions.
Loan loss provisions are cash reserves set aside to cover loans that are unlikely to be repaid. As the US economy enters recession, it is expected that more debtors will not be able to repay their loans. So far, however, delinquencies are at a very low level.
AJ Bell investment director Russ Mould pointed out that changing loan-loss provision “largely explains the year-on-year drop in earnings” from 2021 to 2022.
“The big four took $60bn (£49.4bn) of loan-loss provisions in 2020, wrote back $21bn of those in 2021 and in the first nine-months took a further $7bn in loss provisions,” he said.
“It’s just a matter of how big and how cautious the banks choose to be on their loan books,” Mould added.
Another area of interest will be how investment banking revenue holds up after a poor year in 2022. Mergers and acquisitions dried up, hitting banks with large exposure to the sector.
JP Morgan’s income from investment banking in the third quarter fell to $3.5bn from $5.7bn last year, while Bank of America’s income from global banking fell to $2.0bn from $2.5bn.
Falling revenue from investment banking makes it all the more important that domestic lending holds up for US banks.
JP Morgan, the largest of the US banks to announce results on Friday, is expected to report net income of $7.9bn. This would represent a fall of 24 per cent from the $10.4bn it reported last year.
Analysts at Barclays expect JP Morgan results to benefit from “strong net interest income, healthy trading activity and benign asset quality”. However, conforming to the trend, they also noted that higher expenses, a loan loss reserve build and a lack of repurchase activity” will restrain further improvement.
Expect those trends to be repeated across the other Wall Street giants when they report on Friday.
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