Big banks are expected to report Q1 earnings next week, but the main story could be their expectations for Q2 and beyond, when the financial impact of COVID-19 shows up in the numbers.
Financial sector companies step up to the line to report earnings soon, but in a way it’s too bad they can’t just pass on this snapshot and advance directly to Q2 earnings season.
Not because Q2 results will necessarily be better than Q1 (they might actually be worse), but because investors tend to rely on bank CEOs for a clear perspective on the economic outlook. Executives might have a much better view of the full court in July than they do now.
Like the rest of us, big bank leaders approach Q1 earnings season without a crystal ball. They don’t know how long the coronavirus emergency might last or what its eventual impact might be on their industry or on the other sectors that their lending supports. Things are likely to get rough, but how rough is the question.
By its very nature, the Financial sector is one that gets a courtside seat to the broader economy. It’s the sector that sees the ebb and flow of lending and deposits—at both the business and consumer levels. Plus, it’s where most mergers and acquisitions (M&A) and initial public offerings (IPOs) are negotiated and underwritten. But the economy itself isn’t steering the wheel right now. A microscopic virus is. While the confusion could be helping banks’ bottom lines from a trading volume standpoint, it’s probably hurting them in many other ways—and share prices have responded as such in recent days (see chart below).
By midyear, the success or lack of success from the unprecedented efforts by governments around the world to stave off the economic impacts might be more clear. “While the willingness of policymakers to use all the tools at their disposal is clear, only time will tell to what extent the actions succeed in limiting defaults, closures and layoffs,” Goldman Sachs (GS) analysts wrote in a research note recently.
Also, the medical community might have a better idea by midyear about possible treatments and whether we’re “bending the curve,” so to speak.
At that point, banks will also have a full quarter of the virus under their belts, hopefully allowing them to speak with more authority about how it’s affecting everything from credit card use to student loans to mortgage demand to companies’ ability to pay interest on loans. If brick-and-mortar stores and cruise lines suffer even more—which seems possible—bank leaders might have a better idea by then what the fallout might be for the financial industry.
You’ve got to play the game with the team you have, though, so investors need to prepare for a Q1 Financial sector earnings season where they might get only partial and early insight.
The Financial industry has many credible and senior leaders whom investors can turn to for insight. This is of particular importance this time around. Since Q1 earnings will reflect, to some degree, the pre-virus business environment, the post-release conference calls might be the main event. Some of the questions senior leaders might face include:
There’s a lot of concern building about credit quality and credit risk, market research firm Briefing.com said recently. The full extent of the credit situation probably won’t be clear in time for Q1 earnings season, but bank leaders could potentially provide a lot more visibility on that in their Q2 calls when they know more.
That’s why it might not be worth putting too much emphasis on how banks describe credit quality now, and instead wait to see how it shakes out in Q2. That’s a quarter where some analysts see gross domestic product (GDP) declining 30% or more, and the Fed expects unemployment to potentially reach 30%. We’re on the cusp of perhaps one of the worst quarters in U.S. history, so no one knows quite what to expect. There’s a bottom-up kind of scenario possible, with tenants unable to pay landlords, and landlords unable to pay their own creditors.
One thing to consider watching is whether big banks start adjusting the reserves they set aside for possible credit defaults. Some banks had already set aside more reserves to cover for possible losses starting last year ahead of new accounting rules set to take effect. If they start upping these provisions in a big way, it could mean they see the crisis bringing more pain to their corporate and individual borrowers.
On the bright side (if there is one), many analysts expect the banking industry to see some benefit to Q1 earnings from high trading volume in late February and early March as the market got stretched and pulled like salt water taffy amid the crisis. Investors ran quickly for cover, either taking profit or re-positioning themselves more defensively. This activity could possibly bolster banks’ top lines and perhaps ease some of the bottom-line pressure.
The pressure comes in part from a steep fall in Treasury yields during the quarter. The benchmark 10-year Treasury yield slid below 0.4% at times, down from close to 2% at the start of the year. The average rate for a 30-year mortgage recently stood at 3.5%, down from about 4% a year ago. Falling yields pinch banks’ profits on lending.
Though it might not have been planned, it can be helpful that banks report early in the earnings season. Few other industries have larger megaphones or the ability to set the tone like the biggest financial institutions can. The other sectors are important, too, but they often see things from their own silos.
Combined, the big banks have a view of the entire economy and all the industries, as well as what consumers and investors have been doing. This time around, we’re on unprecedented ground, so it’s good, in a way, that bank executives provide a first look at this strange new economy.
Starting April 14, big banks kick off the Q1 earnings season. The most recent prediction from S&P Global Market Intelligence for Q1 Financial earnings doesn’t look too bad, with an anticipated 0.8% rise from a year ago. However, that’s down from nearly 12% earnings growth for the sector in Q4 of last year.
S&P Global expects Financials to do better in Q1 than the S&P 500 on the whole. It sees earnings for the entire S&P 500 falling 5.1%.
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