Analysts are anticipating banks' net interest margins to fall in the second quarter due to the incorporation of a full quarter of fed funds rate cuts and an increase in liquidity.

The Federal Reserve dropped rates to zero on March 15 in order to help the economy through the COVID-19 pandemic. But low rates, combined with increased liquidity as banks received deposits from Paycheck Protection Program loans and line drawdowns, will hurt banks' margins.

"[NIM] will probably get whacked pretty good," said Nathan Race, an analyst with Piper Sandler Cos., in an interview.

With low rates of return and the temporary nature of deposits from the PPP and line draws, banks are not investing the additional cash but instead letting it sit idle, Race said. "Excess liquidity could weigh on bank margins in the second quarter, particularly since most banks don't necessarily want to reinvest that liquidity into the bond market," said Race. "That's another margin area worth paying attention to."

Ken Zerbe, a bank analyst at Morgan Stanley, agreed, writing in a note that if the deposits are kept in cash, it "could cause material NIM compression." Zerbe modeled a median 27 basis points of NIM compression in the second quarter for midcap banks, incorporating Fed rate cuts and excess deposits.

Given the nature of the pandemic and how it has affected businesses, analysts expect credit quality to be the main focus of second-quarter earnings. "Credit's going to be a big question mark," said Christopher McGratty, a bank analyst at Keefe Bruyette & Woods, in an interview.

Although some industries are expected to have issues, such as restaurants, travel and hotels, McGratty said the credit quality issues could affect several industries, highlighting energy lending as another area of concern for banks. Race pointed to commercial real estate, particularly in the retail category, as an area that may also be hit hard by the pandemic. Analysts will be considering the results of forbearance and deferrals on banks' credit profiles.

Provisions for credit losses to account for the pandemic and its economic effects will still be a main topic, analysts said. "Credit costs and provisioning levels will be higher this quarter than they were in the first quarter, and that's just because the economic data in June compared to March has gotten worse," said McGratty.

Zerbe increased provision expense for his coverage universe by 22%, according to a note. "We expect the banks will continue to build reserves through [the fourth quarter of 2020], to a median of 1.60% (versus 1.46% currently), despite increasing net charge-offs," Zerbe wrote.

For banks with $10 billion to $100 billion in total assets, the ability to maintain dividend payments will be more of a question than it is for large banks, McGratty said.

Overall, banks will still be uncertain about the economic picture going forward and will be unlikely to provide guidance or other metrics as they wait to see how the pandemic plays out, analysts said. "I can't imagine that we will be getting a resumption of fiscal year 2020 guidance from banks," said Race.

"This is like chapter two, and we're not going to know how the book ends for a couple more quarters," said McGratty.