'US Banks Expect 40% Increase in Q2 Net Profit Due to Reduced Allowance for Loan Losses'

by Park Pyunghee

Published 13 Jul.2021 10:18(KST)

[Asia Economy Reporter Park Byung-hee] The Wall Street Journal (WSJ) reported on the 12th (local time) that the US economy is shedding uncertainty and showing a clear recovery trend, raising expectations for a significant improvement in the second-quarter earnings of major US banks.

This week, all six major US banks will release their second-quarter earnings. Starting with JP Morgan Chase and Goldman Sachs on the 13th, Citigroup, Bank of America (BOA), and Wells Fargo will report on the 14th, followed by Morgan Stanley on the 15th.

Investment bank Keefe, Bruyette & Woods expects the banks' second-quarter earnings per share to increase by 40% compared to the same period last year.

Last year in the second quarter, banks set aside large loan loss provisions to prepare for risks arising from COVID-19. However, this year, as the economy improves, loan loss provisions are expected to be significantly reduced, leading to a sharp increase in profits.

However, revenue losses due to decreased trading and sluggish corporate loans are cited as variables.

Quarterly Revenue Trends of Trading Divisions in the Top 5 US Banks [Image Source= The Wall Street Journal]

Citigroup and JP Morgan expect trading revenue to decline by more than 30% compared to the second quarter of last year. They added that this corresponds to about a 10% decrease in total revenue.

According to Barclays Research, the combined trading revenue of the five major US banks?BOA, Citigroup, Goldman Sachs, JP Morgan, and Morgan Stanley?in the second quarter of last year was $33.23 billion. Specifically, equity trading accounted for $9.94 billion, and fixed income, foreign exchange, and commodities accounted for $23.29 billion.

In the first quarter of this year, the five major banks achieved total trading revenue of $33.58 billion, with $13.16 billion from equities and $20.42 billion from fixed income, foreign exchange, and commodities.

Loan performance is also expected to be sluggish. As corporate cash holdings increase, companies have less reason to borrow from banks.

Due to heightened economic uncertainty caused by COVID-19, companies reduced investments, which led to an increase in corporate cash reserves.

While bank lending has stagnated, deposits have significantly increased. According to the Federal Reserve, the central bank of the US, as of the 23rd of last month, deposits at US commercial banks reached $17 trillion. Compared to early last year, this is an increase of $3.8 trillion, about 30%. The $3.8 trillion increase over the past year is roughly equivalent to the total deposits at US commercial banks in 2001.

Total Deposits in U.S. Commercial Banks Over Time [Image Source= The Wall Street Journal]

With loans sluggish and deposits rising sharply, the net interest margin, which indicates banks' profitability, fell to a record low in the first quarter of this year. Analysts expect little improvement in the second quarter as well. Barclays estimates that excessive deposits reduce bank profitability, and if excessive deposits decrease, banks' pre-tax profits could increase by about 5%.

Analysts are paying close attention to whether banks will announce additional share buybacks or dividend plans when they release their earnings.

On the 24th of last month, the Fed announced the results of its bank stress tests (capital adequacy assessments), confirming the banks' capital soundness and lifting restrictions on share buybacks and dividends. Since then, major banks have successively announced share buyback and dividend plans. The per-share dividend amount for the six major banks in the third quarter of this year increased by about 40%.

Analysts believe that as banks announce their second-quarter earnings, they may disclose additional share buybacks or dividend plans, which will determine whether bank stock prices will rise further.