The country's biggest banks are due to report their earnings for the third quarter this week. These results will likely indicate how the financial industry has been navigating some of the biggest headwinds in the country's history: a global pandemic, heightened climate crisis, accelerated digital transformation, competition with fintechs around the globe, and the looming threat of a housing crisis.

Key Takeaways

  • Large U.S. banks kick off earnings season this week facing numerous challenges, including the pandemic and a potential housing crisis.
  • Analysts anticipate earnings for the largest banks to decrease compared to a year ago, but many lenders are taking proactive measures.
  • Banks also face increased regulatory scrutiny as well as pressure to adopt new technologies and increase diversity.

While some analysts anticipate earnings per share (EPS) for the biggest U.S. banks to decrease compared to a year ago, many lenders have been proactively taking aggressive measures and making strategic decisions despite a challenging operating environment. KBW projects EPS for the nine biggest U.S. banks to decrease 16% from the same period a year ago, according to MarketWatch. The SPDR S&P Bank ETF (KBE) is down 30% this year. 

"Banks have some of the highest COVID beta in the market," Mike Mayo, a banking analyst with Wells Fargo & Company (WFC), told Barron's in reference to the banks' exposure and sensitivity to the pandemic's developments. "It's tough to call the exact time, but if you get a sector rotation into the banks, they could be up 10% to 20% in days."

There are signs of housing market trouble around the country, especially in areas that have been particularly vulnerable to climate change and a lack of state-backed pandemic relief. In the absence of additional federal measures, we're likely to see a further spike in evictions and worsening housing crisis. Princeton University's Eviction Lab, which tracks these across 17 U.S. cities, recorded 58,612 evictions as of Oct. 3. Researchers project that "millions of renters will owe significant back rent" and anticipate a "displacement and eviction crisis will follow the public health crisis."

So far, the four largest lenders are setting aside $10 billion in reserves, according to Bloomberg analysts' estimates, indicating that the worst may be yet to come. This week's earnings reports will offer more details on the role the big banks are likely to play in the next chapter of the U.S. healthcare and housing crisis and when some of these reserves may be deployed, which would have an impact on net income.

In the meantime, the banks' third quarter revenue is still expected to decline in the third quarter due to the Federal Reserve lowering its lending rate to zero in March. Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM) are due to report their third quarter earnings on Tuesday, with Bank of America Corporation (BAC), The PNC Financial Services Group, Inc. (PNC), The Goldman Sachs Group, Inc. (GS), and Wells Fargo releasing earnings on Wednesday, Oct. 14.

Bank reserves are the cash minimums that must be kept on hand by financial institutions in order to meet central bank requirements. The bank cannot lend the money but must keep it in the vault, on-site or at the central bank, in order to meet any large and unexpected demand for withdrawals.

Digital Acceleration

It's no secret that many U.S. financial institutions have lagged behind Asia and many countries in Europe when it comes to embracing digital technologies. This year may begin to change that. This week, we're likely to see more banks tout their progress when it comes to digital transformation and client engagement online.

In a push for digital innovation, Bank of America received 184 patents during the first half of this year, a 20% increase compared from the year before, according to the company statement. The bank applied for a total of 415 patents, which is also a record for the lender. These patents span "money transfer, bill payments, ATM transaction pre-staging, check verification using augmented reality, and cardless and device-less authentication technology."

Increasing Regulatory Scrutiny 

As many banks are likely to face more pressure from the ongoing pandemic and strained economy, there is also more regulatory scrutiny in this past quarter. The $1 billion penalty is going to be particularly notable for JPMorgan. JPMorgan, along with United Parcel Service, Inc. (UPS) and TD Ameritrade, are also facing increasing legal scrutiny and lawsuits over alleged patent infringement in the use of the app technology as mobile banking has been growing.

This economic downturn has been different in many ways, including greater regulatory scrutiny, with attention from various government agencies and reports on activities that have largely flown under the radar in recent past. A BuzzFeed report found that Western banks "moved trillions of dollars in suspicious transactions, enriching themselves and their shareholders while facilitating the work of terrorists, kleptocrats, and drug kingpins."

The FinCEN Files investigation showed that, even after they were prosecuted or fined for financial misconduct, banks such as JPMorgan Chase, HSBC Holdings plc (HSBC), Standard Chartered plc (SCBFF), Deutsche Bank AG (DB), and The Bank of New York Mellon Corporation (BN) continued to move money for suspected criminals. It's yet unclear what these investigations will mean for the big banks, beyond the fines, and whether further regulatory measures will be introduced following the 2020 presidential elections.

Stepping Up on Climate Change

While the United States is slated to exit the 2015 Paris Climate Agreement on Nov. 4 and the broader national agenda on climate remains up in the air, many banks are taking proactive steps this year. JPMorgan Chase, the biggest U.S. bank, has set climate targets, which it will announce next year. These climate goals, to be accomplished by 2030, will start with the energy industry and apply to each industry in the bank's portfolio, according to the lender.

"Climate change is a critical issue of our time. The goals set in the Paris Agreement are commendable and ambitious, but the world is not on track to meet them," said Daniel Pinto, co-president of JPMorgan Chase who also serves as CEO of its Corporate & Investment Bank. "While the world has a long way to go, we at JPMorgan Chase want to do more. That means working with clients, policymakers, and advocates to transition our economy and turn the goals of Paris into a reality."

Diversity

The healthcare crisis and global pandemic have revealed many disparities in the U.S. economy. Some of the biggest U.S. lenders have unveiled programs to address diversity and the continuing wealth gap.

JPMorgan Chase made a $30 billion commitment to "closing America's racial wealth gap," which aims to address diversity among its asset managers. "Systemic racism is a tragic part of America's history,” Jamie Dimon, CEO of JPMorgan, has said.

Other banks took steps as well. Bank of America pledged $1 billion over four years to advance and announced investments in diversity. "This summer has brought a new directness, a new candor, and an unwillingness to be so polite anymore about the discussion" on diversity, according to Cathy Bessant, Chief Operations and Technology Officer at Bank of America. 

In a milestone for the banking industry, Citigroup appointed Jane Fraser as CEO in September, making her the first female CEO of a major bank. Still, the industry as a whole has a long way to go.

"I have seen progress in our country, in banking and in federal service. Yet I still see too few people who look like me in boardrooms, in senior leadership positions among federal agencies, and among international bank supervision leaders," wrote Grovetta N. Gardineer, Senior Deputy Comptroller for Bank Supervision Policy, Office of the Comptroller of the Currency, in a column for American Banker. "In those settings, I am still among the very few women, and almost always the only woman of color."

Consumer Loan Losses and Profitability 

As the banks react to the pandemic and the social justice movement it has unleashed, we're likely to see more of these actions reflected on their balance sheets.

"The banks have been flooded with deposits and have nowhere to put it," said Brian Foran, an analyst at Autonomous Research. "Healthy companies don't want to borrow because the future is still uncertain. Struggling companies would like to borrow to stay afloat, but as a bank it’s hard lending to those sectors."

This week, we'll see if the banks will continue their cautious stance, the impact the current environment has had on their net interest income, and how they may be preparing for more turbulent times to come.