Large US banks sweating the move to lower interest rates
President Donald Trump's attacks on the US Federal Reserve make financial markets cringe, but his demand for zero interest rates makes banks sweat.
As the Fed reverses course and is poised to cut the benchmark lending rate a second time on Wednesday, large US banks have signaled they expect a bigger hit to their bottom line. Banks including JPMorgan Chase and Wells Fargo last week trimmed their 2019 forecasts for profits tied to interest rates as central banks around the world loosen monetary policy in response to a weakening global growth outlook.
Lower interest rates mean less profits on loans made by the banks, especially if they have offered higher returns on deposits to attract customers.
Moody's warned in a report Thursday that lower interest rates would crimp bank profitability in general and prompt more mergers in the industry. JPMorgan Chase Chief Executive Jamie Dimon last week said the bank now expects full-year net interest income of around $57 million -another downgrade to the forecast that was $58 billion earlier in the year.
The Federal Reserve in July cut the key interest rate -- which drives the cost of all types of borrowing -- for the first time in more than a decade, after four rate increases last year. The reversal came amid Trump's bitter trade war with China which has increased uncertainty and undermined the global economy, fueling a slowdown in manufacturing and investment.
Trump has relentlessly demanded the Fed cut rates further to catch up to moves by the European Central Bank and others, calling for zero or even negative rates. But most economists view that as highly unlikely and Dimon said he still does not expect such a drastic move.
"I don't think we'll have zero rates in the United States," Dimon said. "We were thinking about how to be prepared for it, just in the normal course of risk management." The possible responses include cost-cutting, as well as charging consumers account fees.
Yet some banking experts say the interplay between interest rates and bank profits is overestimated in importance and more complex than is commonly understood. "The downturn in interest rates is manageable if we don't have a recession," said Marty Mosby, who directs bank and equity strategist at Vining Sparks, a broker-dealer.
And some banks already have put in place strategies to mitigate interest rate risk. History shows that while bank profits may fall incrementally after Fed interest rate cuts, they do not crumble completely, said analyst Dick Bove, who points to numerous instances where profits rose amid low interest rates. "They are conglomerates and there are many ways of making money," he said, including charging premiums to corporate clients due to increased recession risks.
Conversely, Bove said investors also make too much of the boost when rates are rising, and said profits were diluted during the Fed's recent rate-hike cycle by large deposit payments. The benchmark closely watched is "net interest income," which essentially reflects the difference in bank revenues tied to the loans it makes and interest payments to depositors.
Wells Fargo also lowered its estimate for net interest income, projecting a $1.8 billion drop in the second half of 2019 compared with the year-ago period.
The bank could place more of its own assets in longer-run investment vehicles if it expects rates to stay lower for longer, an outlook that depends on "the perceived probability of recession," said Wells Fargo Chief Financial Officer John Shrewsberry.
"If you do go into some sort of deeper economic decline and rates are going to remain low or go lower from here ... you think about protecting the downside," he said. "I don't think we're quite there yet."