Weak bank earnings send bearish signal as COVID uncertainty deepens

In a sign that the banking sector is feeling the pinch of the market turmoil, major US banks reported relatively weak results for the second quarter, kicking off one of the most eagerly awaited earnings seasons. The market has been keeping track of the financial services sector for cues on the impact of COVID and how the economy is emerging from the crisis. It is estimated that the government’s massive stimulus package would help to ease the impact.

Experts warn of a further hike in loan loss provisions, given the devastating effect of the virus attack both on the business world and people’s personal finances. The resultant drop in the availability and demand for credit would remain a drag on interest margin, which is already under pressure due to the low interest rates. Combined, the faltering job market, bankruptcies, and deepening pandemic crisis have put the banking sector on shaky ground, at least for the time being.  

Credit Costs Drag Profit

Citigroup Inc. (NYSE: C), a prominent player in the retail banking space, said second-quarter earnings contracted by about two-thirds to $0.50 per share year-over-year, hurt by higher credit costs, while revenues moved up 5% to $19.8 billion. The top-line benefitted from a sharp growth in the Institutional Clients segment, which was partially offset by deterioration in other areas. Interestingly, total loans remained broadly unchanged, while deposits climbed 18%.

Citi’s credit loss provision was raised sharply to 3.89% of total loans from 1.82% at the end of the year-ago quarter. The latest numbers came in above analysts’ forecast, sending the stock higher early Tuesday. Chief Executive Officer Michael Corbat is bullish about the bank’s ability to navigate the coronavirus crisis and the ongoing efforts to boost liquidity, thereby enhancing the capacity of the balance sheet significantly.

Top-line Shines on Trading

It was a similar scenario at JP Morgan Chase (NYSE: JPM), the biggest US bank by assets. Though earnings plunged about 51% to $1.38 per share in the second quarter, they came in above analysts’ projection even as a record growth in trading volumes drove up revenues by 15%. The stock jumped immediately after the announcement on Tuesday but retreated as trading progressed.

 Related: An earnings season where trading business played god

According to CEO Jamie Dimon, JP Morgan’s exceptional loss-absorbing capacity and liquidity resources would allow it to absorb more credit reserves in the future. It will also help the bank continue the services without disruption and maintain the dividend, unless the economic situation further deteriorates.

Dividend-cut after Q2 Loss

Wells Fargo (NYSE: WFC), which is yet to recover from the long-drawn-out account fraud litigation, took a harder beating from the virus-related slump in the June-quarter when it recorded the first quarterly loss in more than ten years. The company ended the quarter with loan loss costs of around $20 billion, nearly double that in the same period of 2019.

At $0.66 per share, the second-quarter loss reflects the spike in loan loss reserves and marks a sharp deterioration from the $1.30-per share earnings reported last year. Revenues dipped in double digits to $17.8 billion, prompting the management to cut the dividend by 80%. The results also missed the Street view.

Also read: JPMorgan Q2 2020 Earnings Call Transcript

“We are extremely disappointed in both our second-quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter, which drove the $8.4 billion addition to our credit loss reserve in the second quarter,” said Wells Fargo’s chief executive officer Charlie Scharf.

Sluggish Recovery

Unlike the technology industry, the recovery of banking stocks has been quite sluggish since the market collapsed a few months ago. The bourses witnessed continued volatility as the earnings season started, with the highlight being the earnings reports from financial services firms. Though banking stocks, in general, saw an uptick in the early hours of Tuesday’s session, the momentum waned later in the day.