Evening Brief – 07.13.23

While second-quarter earnings season kicked off Thursday, the results of the largest US banks, which will be released on Friday starting with JPMorgan, Wells Fargo and Citigroup, will be the first formidable test for the financial markets. The remaining banks will release their earnings next week.

It’s shaping up to be a tough quarter, even for the large banks, as bank executives have been guiding lower and analysts have been slashing estimates. Wall Street has taken down its projections for the six largest banks by an average of 20%; Goldman Sachs’ earnings estimates have been cut the most at 65% from the second quarter a year ago.

Interest rate cycles have a significant impact on bank earnings. Rising interest rates help banks by increasing deposit volumes and net interest margins. Loan demand, on the other hand, tends to fall. These factors will be prominent in the earnings releases.

Estimates have been cut due to familiar reasons: rising funding costs, slowing loan growth, which are crunching margins, and a decline in M&A and IPO activity, among others.

Meanwhile, loan defaults have been low since 2020, thanks to pandemic stimulus spending and other government support. However, lenders are beginning to feel the adverse effects of increasing interest rates and inflation on borrowers. As a result, US banks are putting more money aside than usual to deal with possibly bad loans.

Banks with more exposure to rising interest rates are likely to fare better. At the same time, those reliant on investment banking, trading, and wealth management are faced with a more challenging environment.

According to Bloomberg estimates, JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley are estimated to have collectively written off $5 billion given loan defaults in the second quarter of 2023. Moreover, banks are expected to set aside $7.6 billion to cover loans that could go bad.