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Photographer: Mark Kauzlarich/Bloomberg
Markets

As Falling Rates Bite Into Revenue, U.S. Banks Turn to Cost Cuts

As Falling Rates Bite Into Revenue, U.S. Banks Turn to Cost Cuts

  • Projected revenue at top six banks has declined by $13 billion
  • Mortgages, consumer seen as bright spots as banks post results
citibank citi SOCIAL
Photographer: Mark Kauzlarich/Bloomberg

Higher interest rates were supposed to be a godsend for U.S. bank earnings this year. But with borrowing costs falling instead of rising, CEOs will have to lean on cost cutting to reach their goals.

When the biggest lenders report third-quarter results next week, investors will be gauging their success in grappling with ever-shrinking projections for net interest income. Estimates for revenue at the six biggest banks have plunged $13 billion since the start of 2019, with muted capital markets and signs the economy is slowing adding to the profit pressure.

Chief executive officers “must control expenses like they’ve never controlled expenses before,” Mike Mayo, an analyst at Wells Fargo & Co., said in an interview. “This is a challenging revenue quarter. We lowered our estimates three times in two months due to low interest rates.”

Less Money to Play With

Banks' projected 2019 revenue has fallen by more than $13 billion

Source: Bloomberg

Bank executives have a lot riding on their ability to trim so-called efficiency ratios, which measure how much it costs to produce a dollar of revenue. Citigroup Inc. is trying to cut its ratio by almost 2 percentage points this year after disappointing investors on that front in 2018. Bank of America Corp. has touted 18 straight quarters of progress on the gauge, while Wells Fargo is seeking to reach its previous CEO’s target before its new boss sets his own agenda.

Efficiency ratios are likely to be unchanged from last year’s third quarter, according to Susan Katzke, an analyst at Credit Suisse Group AG.

Getting that gauge moving in the right direction will depend on how disciplined the companies are in keeping control of costs. There are “three options banks have: expenses, expenses, expenses,” Mayo said.

Read more about Citigroup cutting hundreds of trading jobs

Here’s what else to watch next week, when JPMorgan Chase & Co. kicks off earnings on Tuesday, followed later in the day by Goldman Sachs Group Inc., Wells Fargo and Citigroup:


Interest Rates

The Federal Reserve began its rate-cutting cycle in July. Two months later, JPMorgan, Citigroup and Wells Fargo warned investors that net interest income -- the money banks make from customers’ loan payments minus what they pay depositors -- would fall in the third quarter. Next week they’ll disclose how bad it got.

“Net interest margins fell meaningfully in the second quarter, and we are expecting net interest margins to fall again in the third quarter -- but less than we previously estimated and less than last quarter,” Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods, said in a note.

After inverting and sparking investor anxiety earlier in the quarter, the yield curve is now slightly positive, offering some relief, Kleinhanzl said. KBW estimates NII will fall 2.1% instead of a previously projected 4% drop.

Looking past the third quarter, investors on next week’s conference calls will be listening for clues on how big a hit revenue will take in 2020 from the Fed’s easing cycle, Katzke at Credit Suisse said.

The U.S. Consumer

One point of strength for bank earnings has been the U.S. consumer. With employment levels holding strong throughout the quarter, bank businesses reliant on that sector of the economy are expected to be a boon to earnings.

Consumer confidence hasn’t yet been substantially shaken by growing macroeconomic risks, such as signs of a looming recession and headlines about the worsening trade war.

“When consumers have jobs they tend to borrow more and at the same time keep credit quality in check,” Jason Goldberg, an analyst at Barclays Plc, said in an interview. “You’ve had a very strong employment picture, and most economists forecast that to continue.”

Few delinquencies show the health of U.S. consumers

One area where lower interest rates are helping banks is the housing market. The Mortgage Bankers Association forecasts a 21% increase in originations for the third quarter and a 58% jump in refinancings.

Loans and Deposits

With loans less lucrative and deposits harder to attract, third-quarter price trends for those products will be closely watched, Katzke said.

“It’s good to see solid deposit growth, the issue is pricing/repricing,” she said, adding that while deposit rates will fall overall, competitive pressures may mean rates land at a slightly higher level than the declining rate environment might suggest.

Katze predicts industrywide loan growth will be 1% from the previous quarter and 3% from a year earlier.

The third-quarter results will probably show some banks starting to reduce the rate they pay for deposits, with almost all of them following suit by the end of the year, according Goldberg at Barclays.

Capital markets

While increased volatility benefited some trading books this quarter, there isn’t yet much cause forcelebration.

JPMorgan expects a year-over-year 10% bump to trading revenue. But that increase compares with a weak third quarter in 2018, and the figure will show a decline from the previous three months, CEO Jamie Dimon said at an investor conference in September.

Also last month, Citigroup Chief Financial Officer Mark Mason said to expect a trading-revenue decline, while Bank of America’s chief operating officer, Tom Montag, said fixed-income trading would be down while the equities business was strong.

The pessimistic outlooks contributed to bank shares’ under-performance. The KBW Bank Index has climbed about 13% this year, compared with 17% for the broader S&P 500.

Ticking Up

Analysts expect three of five banks to have higher trading revenue

Bloomberg

“The third quarter is typically a bit slower,” Katzke said. “This year was no different, with trading and investment-banking activity both weaker sequentially, challenged by both macroeconomic uncertainty and seasonality.”

Year over year, investment-banking revenue will be down 4% on average, she said.

September featured unwanted drama in the market for initial public offerings, including We Co.’s postponed IPO. That disappointment will probably show up in lower valuations for banks’ stakes in the company. Earlier this month, Jefferies Financial Group Inc. said it wrote down the value of its investment in We by $146 million. Goldman Sachs will take a $264 million hit on its We stake, according to Betsy Graseck, an analyst at Morgan Stanley.

That’s not the only equity holding that could weigh down profit. Goldman Sachs’s investments in four companies, including Uber Technologies Inc. and Avantor Inc., are set to cost the firm about $260 million, according to filings and company disclosures.