(Bloomberg Opinion) -- Heading into this earnings cycle for the biggest U.S. banks, analysts were already plenty worried about net interest income, which is how much the firms make from customers’ loan payments compared with what they pay on deposits. After all, long-term interest rates have plummeted since the end of last year amid signs of slowing global growth and the Federal Reserve indicating it would soon be cutting its benchmark lending rate.
It turns out they weren’t quite concerned enough.
On Monday, Citigroup Inc. disclosed a net interest margin that disappointed analysts, which raised doubts that JPMorgan Chase & Co. and Wells Fargo & Co. could meet expectations. That’s precisely what happened: JPMorgan, the largest U.S. bank, cut its full-year outlook for net interest income by $500 million. At Wells Fargo, which already lowered its net interest income guidance for the year in April, it fell 4% to $12.1 billion, below even the lowest estimate.
JPMorgan Chief Executive Officer Jamie Dimon, in his typical style, brushed off the revised net interest income estimate of $57.5 billion. It could be higher or lower depending on how many times the Fed lowers interest rates (the bank was expecting no cuts during the last round of earnings). Net interest income “is like the wind blowing” Dimon insisted, adding that it’s more useful to focus on long-term measures like the number of accounts and deposit growth.
That may be, but it matters to investors when the wind is blowing firmly in one direction. When pressed on a conference call with analysts, JPMorgan Chief Financial Officer Jennifer Piepszak described a range of outcomes that could have the Fed dropping interest rates from one to three times in 2019. If the central bank cuts more than once, net interest income could possibly fall to below $57.5 billion, she said.
In more normal times, the Fed beginning a cycle of monetary easing wouldn’t be too painful for banks because they could just lower short-term deposit rates in tandem with long-term rates. But these are far from normal times. Chase Premier Savings interest rates are still next to nothing, for example, just like other big institutions. Simply put, banks got away with keeping deposit rates near zero in recent years because consumers became accustomed to getting paid nothing on their savings in the wake of the financial crisis. That led to blockbuster profits as benchmark U.S. Treasury yields rose to multi-year highs, which in turn boosted the amount earned on loans. But that leaves less flexibility on the way down.
It’s worth reiterating this point because the Treasury yield curve is often seen as a clear-cut way to gauge the health of banks, and it steepened recently after Fed officials made clear their plan to lower interest rates later this month. But when deposit rates are far more sticky near zero than the fed funds rate, it all comes down to long-term yields. That means margins are compressing fast.
Wells Fargo, for its part, is apparently feeling the squeeze on both sides. The drop in net interest margin from the prior quarter was due to “balance sheet mix and repricing, including the impacts of higher deposit costs and the lower interest rate environment,” the bank said in its statement.
Of course, it’s not all bad news for banks if interest rates are falling, provided that the Fed successfully prolongs the longest economic expansion on record. As of now, the consumer remains steadfastly strong: On Tuesday, June retail sales showed a 0.4% monthly gain, easily beating estimates for a 0.2% advance.
Earnings from JPMorgan and Wells Fargo tell the same story. JPMorgan’s consumer and community banking unit generated $4.2 billion in net income in the second quarter, a 22% increase compared with the same period in 2018. Wells Fargo’s second-quarter provision for credit losses was just $503 million, compared with estimates for about $773 million, in a signal that it expects resiliency from its clients in the months ahead.
Still, this round of bank earnings shows there are few easy-money opportunities for these Wall Street behemoths. Just as they’ve shown they can’t count on traders to deliver large profits when central banks are suppressing volatility (perhaps with the exception of Goldman Sachs Group Inc.), they’re also going to have to prepare for a world awash in lower interest rates.
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Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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