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Bank earnings preview: 'Chipping away' at expenses amid a tough environment

Brian Cheung

Earnings season is set to kick off next week with the big four U.S. banks reporting their earnings for the third quarter. Analysts say amid a low growth environment, the big banks will need to prove that they can manage low expenses to maintain their profitability.

“Even in a slower revenue growth environment, banks can still improve efficiency and returns and therefore we see upside to bank stocks,” Wells Fargo Senior Analyst Mike Mayo told Yahoo Finance’s On the Move on Friday.

As of late, margins have been tight at the four largest American banks — JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC). Net interest margin, a key measure of interest collected on loans minus interest paid on deposits, has come down over the last few quarters as an inverting yield curve compressed interest collected on longer-term loans.

Last quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo saw their net interest margins (NIM) decline. Net interest margin is calculated by taking interest collected on loans, subtracting interest paid on deposits, and dividing that difference by average invested assets. Credit: David Foster / Yahoo Finance

Gerard Cassidy at RBC Capital Markets expects net interest margin to continue falling, by 8 basis points year-over-year. Cassidy is projecting year-over-year loan growth of 3.3%. Cassidy wrote Oct. 1 that the large banks have faced macroeconomic headwinds due to uncertainty in the U.S.-China trade war, but said the fundamentals show healthy U.S. banks and recommended that investors go “overweight” on bank stocks.

“The industry continues to manage the modest revenue growth environment by chipping away at operating expenses,” Cassidy wrote.

Expense control

Wells Fargo’s Mayo says changing technological trends should favor banks cutting expenses to hedge against slower top-line growth.

“Everyone’s crying and whining about a couple basis point reduction in the net interest margin,” Mayo told Yahoo Finance. “Oh no boo-hoo, meanwhile we have this multi-decade structural change, the biggest capital-for-labor swap in history.”

Mayo published a report earlier in the month predicting that automation would help the banking industry shed 200,000 jobs over the next decade. Mayo pointed to Bank of America as an example of a bank that has done a successful job at closing physical branch locations and improving its retail customer experience on mobile platforms.

Even though JPMorgan Chase is actually expanding its retail footprint, Mayo said the company is a “best in class, global bank.” But Mayo was cautious about Citigroup, where he is skeptical that the company will be able to meet its goal of 12% return on tangible common equity for the fiscal year 2019 and then 13.5% for the fiscal year 2020.

At Wells Fargo, eyes will be on newly named CEO Charles Scharf. Cassidy wrote Sept. 30 that given the reputational issues at the company, Scharf should be “candid” and tell investors that the turnaround effort will take two to three years to fix.

“Following a honeymoon period that will be used to determine the best course of action to solve WFC's problems, Scharf and his management team will need to disclose the plans to investors and then execute on them,” Cassidy said.

Overall, the macroeconomic backdrop is still tough for the four bank stocks, which have underperformed the broader market in the last 12 months.

“The banks did not expect rates to be this low, the yield curve to be this flat,” Mayo said.

Citigroup, JPMorgan Chase, and Wells Fargo will all kick off earnings before the bell on Oct. 15. Bank of America’s earnings are scheduled pre-market on Oct. 16.

Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.

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