Enjoy the good times while they last.
Big banks kicked off second-quarter earnings season on Friday by generally reporting stronger profits from a year earlier, boosted by a mix of tax cuts, a strengthening economy and loan growth. JPMorgan Chase hit a quarterly record, while earnings at Citigroup rose by double digits, thanks in part to its investments in consumer banking. The embattled Wells Fargo remains an outlier.
Asked about the state of the economy, JPMorgan Chairman and CEO Jamie Dimon said there are few signs of a downturn in the near future. He pointed to a range of positive indicators, including increases in capital expenditures, a stronger job market and a banking system that is “very, very healthy” compared with the pre-crisis period.
“If you’re looking for potholes out there, there are not a lot of things out there, and growth is accelerating,” Dimon said. Moreover, the flatter yield curve is not necessarily a predictor of a future recession, he said.
Still, if you dig a little deeper into big banks’ quarterly results, the CEOs have plenty to worry about.
Consider the outlook for deposit costs. Citigroup, the fourth-largest bank by assets, said it plans to move forward with raising deposit rates for consumers, as it looks to add cheap deposits. The move could put additional pressure on the company’s net interest margin.
Additionally, JPMorgan took its lumps in credit cards. After making waves with the launch of its benefit-heavy Sapphire Reserve credit card, the company took a $330 million charge stemming from the rewards it offers to customers. Charge-offs within the portfolio also increased.
CEOs at a number of big banks also described the prospect of a trade war as a looming risk on the horizon.
Here is an overview of three major risk areas: deposit prices, consumer credit and the impact of tariff fights and other trade-related clashes.
Higher deposit rates on tap
JPMorgan Chase and Citigroup have resisted paying higher rates on retail deposits. Executives at Citi admitted on Friday that is finally going to change during the second half of this year.
Deposits remain the best source of low-cost funding for loan growth, a key strength that banks wield over upstart online lenders, insurance companies and other nonbank lenders. Banks have enjoyed paying rock-bottom deposit rates for years, but the Fed’s series of rate hikes has led many regional, community and online banks to boost deposit rates.
Not so at the largest banks, which continue to pay some of the industry’s lowest rates on savings accounts, money markets and certificates of deposit, executives said.
“Reprice is still not happening” at the largest banks, JPMorgan Chief Financial Officer Marianne Lake said during a conference call with analysts and investors.
As a result, many JPMorgan and Citi customers are moving their money to different parts of the bank, especially to wealth management products. Both banks said that customers are shifting cash from checking and savings accounts and money markets into investments.
The shift from money markets to investments was a primary factor behind the 3% year-over-year decline in average deposits in North American consumer banking at Citi, to $180 billion, Chief Financial Officer John Gerspach said during a conference call.
Total deposits at Citi rose 4% to $997 billion on a yearly basis, although that total includes Citi’s substantial exposure to non-U.S. markets.
Otherwise, price competition with online and smaller banks has not yet affected JPMorgan, Lake said. During the second quarter, retail deposits at JPMorgan climbed 5% from a year earlier, to $673.7 billion. That is a slower pace compared to previous quarters, when growth reached double digits.
To be sure, because of deposit growth and relatively higher rates being paid on many commercial accounts, big banks’ interest costs are already on the rise. Interest expenses rose 56% at JPMorgan Chase and Wells Fargo year over year, and they increased 46% at Citigroup. (See chart)
Those numbers will eventually climb higher as consumers are becoming more price sensitive and big banks finally start making adjustments — which they say will happen.
“Our expectation is that those U.S. retail deposit [prices] will increase in the second half of the year,” Gerspach said. He did not provide additional details on the precising timing or extent of rate increases.
In addition to raising rates, both Citi and JPMorgan are investing in technology to help gather more deposits. Citi plans to introduce a new digital-only bank in the coming months that will include “enhanced deposit-taking capabilities,” Gerspach said.
In JPMorgan's development of Finn, a mobile bank for millennials, the app will enable customers to open accounts online, Lake said.
Warning signs in credit cards?
Consumers are getting more sophisticated in how they track and claim credit card rewards—and that’s taking a bite out of profits.
During the second quarter, JPMorgan took a $330 million hit on what it described as a “rewards liability adjustment” within its credit card division. In total, card income at the New York company fell 13%, to just over $1 billion.
Credit card consumers are getting more savvy about redeeming rewards, Lake said. Still, she put a positive spin on the matter, describing it as a sign that customers find value in the cards that JPMorgan offers.
“It’s more about customers’ awareness of the value proposition of rewards, and them being engaged in redeeming them, which for us is a net positive thing because engaged customers spend more,” Lake said. “They will bring us more of their share of deposits and investments as we deepen relationships.”
Lake described the charge as “a little larger than normal,” noting that the company regularly takes charges to account for the cost of its credit card rewards.
Asset quality also weighed on JPMorgan’s credit card results. The net charge-off rate within the division climbed 26 basis points, to 3.27%.
Card revenue at Citigroup also declined, falling 1% to $2.1 billion within a portfolio that includes both Citi- and store-branded cards. Revenue from retail services cards — or those that can only be used at a single retailer, such as Home Depot or Sears — rose 1% to $1.6 billion.
One of the factors dragging down card revenue is promotional balances, which the New York company has used aggressively in recent months to attract new customers. Now, the bank is backing off its aggressive use of promo rates, Gerspach said.
"We expect to continue to see the runoff in promo balances ... and we reduced the overall volume in new promotional activity," Gerspach said. "Those are obviously accounts that cost us money. We don't earn anything on a promo balance."
About half of Citi accounts with promotional balances convert into interest-earning balances once the promotional rates expire, Gerspach said.
Trade wars loom
The Trump administration’s ongoing trade war with China, its European allies, and Canada and Mexico may soon start to put a damper on banks’ business. But nothing major has happened yet, JPMorgan and Citi executives said.
The U.S. decision to impose a 25% tariff on some Chinese imports is still in its early stages, which means that it has affected the psyche of traders and investors more than it has the economics, Dimon said.
That does not mean it won’t be bad for trade, he said.
“There are unpredictable outcomes when you start skirmishes like this with multiple countries,” Dimon said.
Citi, which does much of its business outside the U.S., offered similar views.
“When we look at the trade rhetoric, it certainly introduces volatility, but we have not yet really started to see any significant changes in behavior,” CEO Michael Corbat said during a conference call. “Markets have the fears of what that rhetoric leads to, but at this point we’re not seeing it coming through the numbers.”
If anything, Citi expects that its international trade business may just shift to different clients, instead of being reduced, Corbat said.
“Supply chains or trade routes may realign, but they don’t go away,” Corbat said.
JPMorgan also says the retaliatory tariffs may eventually lead to more challenges or slower growth. “But at this point it’s more of a risk narrative than it is an actual driver,” Lake said. “But it’s important that that uncertainty is taken off the table.”