Wall Street banks go into earnings season under a cloud of rising costs

The largest US banks report earnings this week under pressure to rein in ballooning costs,

The largest US banks report earnings this week under pressure to rein in ballooning costs, with Wall Street lenders being squeezed by rising pay and heaving spending on technology to compete with fintech challengers.

Both JPMorgan Chase and Bank of America, two industry bellwethers, have already raised their outlooks for expenses multiple times for this year. Now costs have emerged as “a great wild card for the quarter and for the outlook” of the industry, says John McDonald, senior analyst for large-cap banks at Autonomous Research.

For the third quarter, analysts expect bank earnings will be propped up by fees from wealth management and a record amount of dealmaking, as well as the return of credit card fees that were waived during the pandemic.

Nevertheless, Wall Street analysts predict revenue declines at JPMorgan, Citigroup and Wells Fargo as a slight uptick in loans is unlikely to offset the blow from historically low interest rates, according to FactSet data.

Costs are traditionally viewed as the primary levers banks could use to manage earnings in an industry heavily dependent on interest rates and credit cycles.

US heavyweights such as JPMorgan have already responded to persistent revenue headwinds from low rates and sluggish loan demand by closing branches and cutting staff.

But those savings have so far been used to fund higher pay and technology spending and buttress their businesses against financial technology competitors.

Analysts forecast JPM, Goldman, Morgan Stanley and Citi will report negative operating leverage in the third quarter, meaning costs rose more year on year than revenues.

JPMorgan is the first bank to report earnings on Wednesday. BofA, Citigroup, Morgan Stanley and Wells Fargo report a day later and then Goldman Sachs on Friday.

Despite a brief recession, near-zero interest rates and sluggish loan demand, the largest US banks have been able to print record profits over the past year due to a surge in trading revenue and massive reversals of loan loss provisions that sent billions of dollars directly to their bottom lines.

However, the boost from those trends is starting to wear off, causing concern about the industry’s longer-term ability to increase profit.

Fixed income trading, which helped Goldman report record profit earlier this year, is expected to drop 20 per cent across the industry as trading returns to more normal levels, according to Coalition Greenwich data.

Banks have released 60 per cent of the reserves they set aside to account for bad loans during the pandemic and future releases are expected to be much smaller, say Goldman Sachs analysts.

Adding to the expenses burden is higher pay driven by a costly war for talent on Wall Street, especially in roles where remuneration is tied to performance such as investment banking.

“The top producers are getting paid more,” said Jeff Harte, a banking analyst at Piper Sandler.

The uncertain revenue forecast is putting pressure on banks to rein in costs at the same time executives say more investment is needed in the business, setting up a potential tug of war between executives and their investors.

“We do not manage the company so we could tell analysts what the expense number is going to be,” JPMorgan chief executive Jamie Dimon told analysts on last quarter’s earnings call after the bank increased its expense target.

Still, analysts including RBC’s Gerard Cassidy expect banks will soon start announcing broad cost-cutting initiatives to appease shareholders if expenses keep creeping up without higher revenue to match.

“Although we expect 2021 to be a challenging year for banks to control operating expenses,” RBC Capital Markets analysts wrote in a note, “the banks that demonstrate they can manage expenses efficiently in the current environment will be likely to be awarded better stock valuations.” 

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