How the Fed Will Impact Bank Earnings

Investors in big bank stocks, which plunged near bear market territory when the Federal Reserve turned dovish in March, will be looking closely at five key indicators when they report Q1 results in the next few weeks, beginning on Friday with JPMorgan Chase & Co. (JPM) and Wells Fargo Corp. (WFC).

Banks as a group are expected to post a 1% gain in consensus earnings for the quarter, which is good news on the surface compared to an estimated decline for S&P 500 companies, per Goldman Sachs. Nonetheless, investors will be watching closely at how much the Fed's dovish policy, including holding off rate hikes, will have on net interest margins, mortgage banking, and lending overall, according to several stories in the Wall Street Journal.

Bank Earnings: 5 Things Investors Are Looking For

• Net interest margins
• Mortgage lending
• Equity underwriting
• Lending growth
• Management’s economic outlook

Source: Bloomberg, Wall Street Journal

Bank net interest margins, which have steadily climbed for four years, are now at risk of declining, as outlined by a WSJ report. The margin for all U.S. banks was 3.34% in Q4, a jump from 2.95% in Q1 2015, per data from the Federal Reserve Bank of St. Louis. “Banks need rising interest rates to support their net interest margins, which are a big profit item and something that’s closely watched by investors in the bank sector," says Patrick Healey, founder and president of Caliber Financial Partners.

Investors will also focus on mortgage lending at banks such as JPMorgan and Wells Fargo. Among the top 24 banks, mortgage lending profitability dropped 19% on average in 2018 from a year earlier, per data from Inside Mortgage Finance.

Equity underwriting may also be under pressure. In Q1, IPO volume was dragged down by the government shutdown, and M&A activity was also relatively low. Credit Suisse analysts estimate that equity underwriting fell 42%.

One area of good news is lending growth, a key driver for banks, which has been surprisingly tepid during much of the economic expansion. Through the end of March, commercial and industrial loan growth rose 10%, per Fed data.

Investors also will be listening for whether bank CEOs or other top management see the economy continuing to slow, or if it's stabilizing after the Fed changed its policy on fears of a possible recession. “We are prepared for—though we are not predicting—a recession,” JPMorgan Chief Executive James Dimon recently wrote in a letter to shareholders.

The myriad of headwinds facing bank stocks has driven the KBW Bank Index down more than 13% off its 52-week high. Bank stocks are now trading at a depressed 11.2 times forward earnings, according to Keefe, Bruyette & Woods, per the WSJ, compared to the five-year average at 14.5 times, marking their biggest discount to the S&P 500 since the early 2000s.

To be sure, the outlook for banks isn't as dire as it looked for much of 2018. Goldman Sachs, for one, is forecasting bank profits will accelerate throughout the year and rise 8% for full year 2019, the best of all the sectors. For that growth to happen, the economy may have to improve dramatically and it will require key bank businesses to offset those lines hurt by Fed policy.