Four trends to watch in second-quarter bank earnings

Despite a first half overshadowed by heavy inflation and rising interest rates, banks are expected to report relatively resilient second-quarter earnings, analysts say. However, investors will be digging through the results in search of any signs of mounting economic stress.

Noninterest income will be scrutinized for slowdowns in investment banking income or mortgage demand, and the effects of higher wages and salaries will be sought in breakdowns of noninterest expenses.

While deposit costs overall aren’t expected to rise substantially in the second half, bank executives could drop hints about how much they expect to compete for deposits between now and year-end.

Investors and analysts also will be on guard for any indications of credit-quality deterioration, though credit is not forecasted to start weakening until the second half. However, small-business lending will be carefully watched for signs of trouble.

Here is a more in-depth outlook for the top aspects of second-quarter results analysts say they will monitor as quarterly reports begin to roll in this week.

Fee income

Several components of fee income, including mortgage banking, investment banking and consumer service charges, are expected to show strain in banks’ second-quarter results.

Investment banking fees will likely be down by 45%-50% year over year amid market volatility, according to Deutsche Bank analysts. The Deutsche analysts also expect weaker fee income from mortgages, since refinancings have largely dried up, and from the wealth management business.

Large and regional banks that have made consumer-friendly reforms to their overdraft programs may also feel the pinch. Customers of the 25 largest U.S. banks are expected to save $4 billion per year as a result of those changes, according to a recent analysis by the Pew Charitable Trusts.

On the flip side, trading has held up better than expected, led by fixed-income trading, according to the Deutsche Bank analysts.

And large banks with leading credit card businesses are likely to benefit from fees that result from higher card loan balances, according to CFRA analyst Kenneth Leon. He pointed out that the U.S. personal savings rate, which reached 18% earlier in the pandemic, ended May at 5.4%.

Noninterest expenses

Rising wages, investments in technology and a resurgence in certain types of spending that fell earlier in the pandemic are all expected to put upward pressure on banks’ expenses in the second quarter.

In the first quarter, the industry recorded $133.8 billion in noninterest expenses, up 7.2% from the same period a year earlier, according to Federal Deposit Insurance Corp. data. That total included $67 billion in spending on employee salaries and employee benefits, the highest amount on record.

Wage increases have continued amid inflation that has hit a four-decade high. Bank of America and Truist Financial both recently bumped their minimum wages for U.S. employees to $22 an hour, while BMO Harris Bank committed to $20 an hour and JPMorgan Chase will pay between $20 and $25 an hour, depending on the worker’s location.

And after pandemic-era declines, banks are also spending more in areas such as marketing and employee travel, according to analysts at Wedbush Securities.

Also driving up expenses is higher spending on digital banking, data analytics and automation, though some of those investments are being offset by branch closures, the Wedbush analysts wrote in a recent research note.

With rising inflation leading to higher employee wages, alongside increased investments in technology, banks paying more expenses shouldn’t be “new or shocking,” according to Christopher McGratty, head of U.S. bank research at the investment bank Keefe, Bruyette & Woods.

While banks often report a “natural seasonal bump in costs” reflecting new expenses during the first and second quarters of each year, the question will be “how much falls to the bottom line,” McGratty said during an interview.

Deposit costs

Bank deposits climbed with little effort for much of the past two years, but the Federal Reserve’s interest rate hikes are threatening to revive cost pressures for banks.

Though the pressures are in their early days, depositors have taken notice of the Fed’s aggressive pace of rate increases and are beginning to push their banks to pay them more.

Commercial depositors are increasingly asking for higher rates, bank consultants say, and some banks are feeling more compelled to meet those requests.

“You’re seeing rate competition come back to the market a little bit sooner than we would have expected,” Peter Serene, director of commercial banking at the consulting firm Curinos, said in a recent interview.

The development could push up banks’ interest expenses and therefore narrow their profits, so analysts are watching for any commentary from bank executives on the issue. They also are poring through bank filings to figure out which ones have more stable deposits — those that are less likely to leave the bank to chase better-paying options or ask for higher rates.

Banks with higher levels of consumer deposits should fare better because they are less likely to reprice quickly compared to commercial deposits, RBC Capital Markets analyst Gerard Cassidy wrote in a note to clients.

His report — entitled “Deposits, Deposits on the Wall, Who Are the Fairest of Them All?” — flagged Capital One Financial, Wells Fargo, Truist Financial and PNC Financial Services as institutions with a larger portion of consumer deposits.

Credit quality

Everybody’s watching for signs of a breakdown in credit quality, but the long-term outlook remains blurry.

Analysts say there probably won’t be much to see in the way of deterioration in second-quarter reports. Unemployment levels are historically low, banks have an abundance of capital, and consumer balance sheets remain healthy.

Yet it could be a different story for the second half of 2022 and beyond.

Concerns are growing that the economy will slip into a recession and will take a sharp turn.

Echoing recent comments made by JPMorgan Chase CEO Jamie Dimon, Wedbush Securities analysts said the “economic tropical storm” at hand could morph into a “hurricane.”

“We concur that the current weather appears sunny” in part because of “excellent credit trends with no signs of cracks except for low-end consumer loans,” the analysts wrote in a June 30 research note. “However, peering through the telescope six months ahead brings into focus potential challenges,” including a reduction in loan demand, a slowdown in deposit growth and higher credit costs “given unsustainably low levels.”

Credit officers told Piper Sandler analysts that they are keeping close tabs on small businesses, where the first cracks in credit quality in two years could soon appear.

A downslide in credit quality, which would show up in charge-offs and delinquencies, could mean that banks have to go back to boosting their loan-loss reserves.

Given that the odds of a recession have increased, analysts at Wells Fargo Securities said in a recent report that they expect to see banks building their reserves in the second quarter. How much they will feel the need to increase reserves is unclear.