“2020 has been a disaster,” said Jim Shanahan, who covers banks at Edward Jones. “It wasn’t the banks’ fault. It was like we had an alien invasion in the second quarter.”
The biggest driver of shrinking profits — or outright losses, in Wells Fargo’s case — is the fact that banks are preparing to deal with a pile of toxic loans caused by the pandemic.
$2.1 trillion in credit losses
Analysts agree that banks will be forced to further increase loss-absorbing reserves — but the real question is by how much.
“It’s going to be really ugly,” said Kyle Sanders, also a banking analyst at Edward Jones.
S&P Global Ratings warned last week that banks around the world will ultimately suffer credit losses of about $2.1 trillion between this year and next.
Beyond bankruptcies and high unemployment, bank profitability is getting crushed by extremely low interest rates. Banks make money off the spread between interest charged on loans and what is paid out on deposits. Right now, that spread is very narrow, making it challenging to make money.
Worse, the Federal Reserve has signaled zero interest rates aren’t going away anytime soon.
“Core earnings power is still a challenge in a ZIRP [zero interest rate policy] world,” Jefferies analyst Ken Usdin wrote in a note to clients last week.
Wells Fargo’s first dividend cut in a decade
Indeed, Wells Fargo is the only major bank expected to swing to a loss during the second quarter, a point that underscores just how much it was struggling even before the pandemic.
The problem for Wells Fargo is that it has fewer financial levers to pull than its peers.
Unlike its rivals, Wells Fargo can’t make more loans to offset low interest rates. That’s because Wells Fargo is still prohibited by the Federal Reserve from growing its balance sheet (except to make small business loans under the federal government’s Paycheck Protection Program).
And Wells Fargo can’t cut costs too deeply because its scandals have forced it to ramp up spending on compliance and technology.
Wells Fargo isn’t the only big bank with a shrinking stock price. JPMorgan, Bank of America and Citigroup have all lost about one-third of their market value this year.
Greed is making a comeback
The bright spot in the banking industry has been the investment banks because they are cashing in on resurgent capital markets.
Resurgent pandemic means more credit losses
Beyond navigating turbulent markets, banks are also grappling with rising coronavirus infections in Sun Belt states including Texas, Arizona and Florida. And big banks have enormous exposure to coronavirus hotspots.
Bank of America had $591 billion in deposits in the top 50 counties across the United States that have seen the most new coronavirus infections over the last month, according to a Morgan Stanley analysis. JPMorgan ($427 billion), Wells Fargo ($389 billion) and US Bancorp ($151 billion) followed as the banks with the most exposure in dollar amounts to these counties.
The health crisis in those areas and risk of renewed restrictions will cause “increased stress” for local businesses and potentially greater credit losses for banks, Morgan Stanley said.
Add that to the list of obstacles facing banks right now.