US banks look ahead to a difficult earnings season

The move into negative rates around the world has not been kind to the banking sector. With US banks now about to issue their latest earnings updates investors will get a good look at just how much damage has been done.

Despite some expectations the Federal Reserve will raise rates in December, it looks like the low interest rate environment in the US is with us for a lot longer than many thought. Net interest margins for US banks are expected to fall to 3.03% for 2016, from 3.05% in 2015, with a further drop towards 3% coming in 2017. Funding costs are likely to keep rising as liquidity in the broader market dries up and LIBOR begins to move higher before money market reforms take place later this month.

Fortunately for banks, the pressures on net interest margins have been offset to a degree by loan growth. Regional US banks, including the troubled Wells Fargo, saw net interest income rise substantially in Q2, on both month-on-month and year-on-year views, so with higher loans to assets boosting overall margins, the domestic US banking sector still has attractive elements to it.

Wells Fargo was one of America’s most profitable banks in 2015, seeing a 1.3% return on assets. Unfortunately, the recent scandals have tarnished the bank’s reputation, and the risk of further scandals and fines will cast a long shadow over its earnings. Citigroup, Goldman Sachs and Bank of America currently trade below their book values, indicating the shares value the company at a price below that of its balance sheet, making them look attractive. JPMorgan and Wells Fargo trade at 1.1 and 1.4 times respectively, so by comparison with the rest of the sector they look ‘expensive’.

Trading revenues at the major institutions are expected to improve, as activity picks up thanks to brightening economic prospects, although we can expect some commentary on how Brexit has hit risk appetite.

The Dow Jones US banks index has considerably underperformed both the Dow Jones and the S&P 500 so far this year, falling 3.6% versus gains of 4.5% and 5.4% respectively for the two indices. However, the index was down over 20% in February, so the rebound has been impressive. If Q3 can beat expectations, then we might see this gap shrink further, although it will not be an entirely positive quarter. 

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