Two of the three big banks that reported results on Tuesday still earned a lot of money in the second quarter. That is less reassuring than investors might hope.
Underlying the banks’ relative resilience in the second quarter were some arguably temporary benefits that don’t really address the long-term economic risks. Reserve builds in anticipation of future credit losses remain a major swing factor for earnings at Citigroup (C), JPMorgan Chase (JPM), which turned profits, and Wells Fargo (WFC), which didn’t. But bankers stressed that their provisioning remains highly subjective and they lack much visibility into the true health of consumers, the biggest source of credit risk.
The reports did resolve some near-term questions for investors. Dividends for now appear to be well safe at JPMorgan and Citigroup. Thanks to a tidal wave of investment-banking and trading fees, these banks are still actually adding to their core equity capital levels. Wells Fargo is a bit of a special case due to asset-growth limitations imposed on it by the Federal Reserve, and has already said it would be cutting its dividend.
But the quarter provided little that should give investors marginal comfort on the more complex questions that will loom going forward. That includes whether the additional loan-loss reserves set aside in the second quarter represent the peak, and what banks’ earning power will look like in a stagnant economy at zero interest rates.
Bankers emphasized that while they are seeing hopeful signs, such as a stabilization of spending through June, massive government stimulus and unemployment benefits have made it difficult to gain a true picture of consumers’ future health. Citigroup Chief Financial Officer Mark Mason told reporters that there are “a number of factors that make it hard to determine with any level of precision how [consumer activity] will unfold.” JPMorgan’s Jennifer Piepszak said: “The visibility on the economic damage is not very good.”
Even the hopeful indicator of how many people in forbearance, or recently leaving forbearance, remain current on their loans isn’t terribly reassuring. Both Citigroup and JPMorgan suggested that around 50% of card borrowers in forbearance are still making payments. JPMorgan also noted that 80% of people who rolled off forbearance programs were making payments. That still leaves a large group of people for whom government stimulus apparently hasn’t been enough.
In addition, banks by necessity are forecasting possible future losses from base-case scenarios, or have weighted outcomes with probabilities that are ultimately unknowable. Citigroup estimated a 15% probability that the economic recovery is “materially slower” than its main forecast, which would imply an unemployment rate about 4 to 5 percentage points higher than the base forecast through 2021. Investors who see big upside in banks at current valuations will need to make their own judgments about how likely such scenarios are.
As for the surge in trading and capital markets, it is hard to see those gains being repeated in future quarters. JPMorgan said it expected a slowdown that began in June to continue. Forecasting market performance is even more challenging than usual—and it is usually pretty tough.
Meanwhile, there are signs that risks are spreading beyond consumers. Second-quarter reserve builds for wholesale and commercial lending went up far more than they did for consumer loans across the three banks. Plus, companies are borrowing less. Commercial and industrial lending at JPMorgan was down 7% from the first quarter, despite the jump in Paycheck Protection Program loans.
While the broader stock market appears to be focusing on rosy scenarios, banks certainly aren’t. Investors looking for evidence of a strong and rapid economic rebound will need to look elsewhere.
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