Bottom-line won’t be a decisive factor as major banks report earnings next week

The big four banking firms will next week kickstart a unique earnings season that is likely to see longer conference calls with most discussions surrounding the impact of COVID-19. The Securities and Exchange Commission has given public companies clear instructions to address these impacts with utmost transparency, and unlike the usual style of bending facts in a way that is favorable to them.

We will get a taste of these new regulations as JPMorgan Chase (NYSE: JPM) and Wells Fargo Corporation (NYSE: WFC) announce their quarterly results on Tuesday. Meanwhile, neither the bottom-line result nor the comparison with analyst predictions is going to make much sense this quarter, given the market is still in the process of analyzing the dent caused on the economy by the virus that has traveled halfway across the globe.

Easing liquidity concerns

COVID-induced spike in unemployment rate to a record 6.6 million in the final week of March will force major US financial institutions to increase their provisions for credit losses, putting pressure on the bottom-line. However, the worst may be yet to come. Experts believe the rate would gain steadily in the coming months, hitting a peak around the last end of July.

In order to ensure the liquidity of funds, several major banking firms including Morgan Stanley (NYSE: MS) and Citigroup (NYSE: C) have already announced the suspension of share buybacks through Q2.

This voluntary action, determined jointly by all member banks, positions Goldman Sachs to deliver greater capital and liquidity to our clients as they seek to navigate challenged markets. The firm stands ready to deploy all of its resources as it engages with its corporate and institutional clients and makes specific accommodations for its consumer and small business customers.

– Goldman Sachs Group on buyback suspension

When it comes to earnings estimates, not all analysts have accounted for the impact of COVID-19 and yet, the average target has seen a considerable decrease among all major banks. Over the past three months, the average earnings estimate has decreased 16.5% for JPMorgan Chase, 38.5% for Wells Fargo, 43.5% for Goldman Sachs (NYSE: GS) and 26% for Citigroup. And the actual impact could be a lot different than what is expected. Separately, there is a new regulation that calls for additional provisions for loan losses, making estimation even more unreliable.

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Focus on net interest margin

There will be a renewed interest in net interest margin, given the backdrop of five interest rate cuts in the past six months. This was part of the Federal Reserve’s efforts to encourage loan growth and boost the economy. While the flattening yield curve was already a point of contention among bank investors, a likely increase in default rates (due to COVID-19) could materially hurt bank earnings.

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Given the recent turn of events, banks are now forced to commit to efforts that will lift the ailing economy. In the last two months, JPMorgan has committed close to a billion dollars in loan originations to support small businesses. Goldman Sachs has also announced two initiatives worth a total of $300 million on similar lines.

Wells Fargo joins lending efforts

Following the temporary lift of restrictions placed on Wells Fargo’s asset limit, the banking firm has announced that it would join the efforts to help small businesses.

 In the first two days alone, we received more than 170,000 indications of interest from our customers, and know there is much more need.

– Wells Fargo CEO Charlie Scharf

Wells Fargo will give out loans as part of its Paycheck Protection Program, under the condition that it would transfer any profits from this either to the Treasury or any non-profit organization recognized by the Fed. We will get to know more details about the program during the conference call.

The SPDR S&P Bank ETF and First Trust Nasdaq Bank ETF, which track banking stocks, are down 34% and 35% respectively since the beginning of the year, much worse than S&P 500’s 13% dip. Major bank earnings would provide ample idea about the strength of the financial industry and the economy as a whole. Hopefully, it will be better than what we are expecting.