Investors have questions about how a new Federal Reserve rate-cutting cycle will affect the largest U.S. banks and will be looking for answers as third-quarter earnings season begins Friday.
First up are the results of JPMorgan Chase (JPM) and Wells Fargo (WFC), followed next week by Bank of America (BAC) and Citigroup (C).
Analysts expect all four of these major banks to report that their net profits fell compared to the previous quarter and the year-ago period, as high interest rates in place for most of the third quarter wiped out lending margins.
But after the Fed cut rates by half a percentage point on September 18, and more cuts are expected this year and next, the key question for many investors is what will happen to future margins when borrowing costs start to fall.
The largest institutions are already cutting the amount they charge new borrowers, tapping a key source of interest income that boosted profits in 2022 and 2023 as the Fed pushed rates higher.
But there’s also a good chance they won’t have to pay as much to hold on to their customer deposits, which could lower their costs and increase margins over time.
How this all plays out is still a big unknown, and investors will be listening this week and next for any changes to the future outlook based on the Fed’s new interest rate path.
“I sense some concern about full-year trends and how banks will handle a rapid move in interest rates,” Scott Siefers, director and equity analyst at Piper Sandler, told Yahoo Finance.
‘Overearn’
The most important metric to watch is net interest income, which measures the difference between how much banks earn on their assets and what they pay for deposits. And the spotlight will, as always, be on JPMorgan, the industry’s largest bank.
JPMorgan posted record profits in 2023 as the Fed pushed rates higher to cool inflation, and its shares are up more than 24% so far this year – outperforming most of its rivals.
But in recent quarters there have been signs that net interest income is coming under renewed pressure as deposit costs rise. And executives have tried to lower Wall Street expectations, warning that the bank had “overearned.”
Just last month, JPMorgan COO Daniel Pinto warned investors that the consensus among analysts that the bank should generate net interest income of $91.5 billion by 2025 was “not very reasonable,” in part because of the timing and effect of the falling interest rates.
“The [net interest income] Expectations are a little too high,” Pinto said during a speech at a Barclays conference.
Shares of JPMorgan fell the most intraday since 2020 after Pinto’s comments.
Some analysts are adjusting their views on JPMorgan as interest rates fall. Last week, analysts at Morgan Stanley downgraded JPMorgan from overweight to equal weight, saying the New York lender was expected to benefit least from falling interest rates next year.
“We see fewer positive surprises for JPMorgan after a strong run over the past two years,” Morgan Stanley’s Betsy Graseck wrote in a note.
Because JPMorgan’s shares did so well when the Fed tightened rates, there is less room for upside compared to peers as the Fed eases, she added.
One vulnerability for JPMorgan and other big banks is that variable-rate loans that earned more interest income when rates rose will now be priced lower.
Another is that because these same giants didn’t have to raise their deposit rates as much as regional banks did during the Fed’s tightening cycle, they will now benefit less directly from cheaper financing, said David Fanger, senior vice president of Moody’s Ratings.
“We believe that the revaluation of deposit costs will be slower than that of variable rate assets,” Fanger told Yahoo Finance. “But over time, we think the price of deposits will catch up.”
The challenge for any bank is to quickly reduce certain deposit costs at the start of a Fed austerity cycle.
That’s especially true when it comes to longer-term CDs and higher-yield savings accounts that are offered at so-called “exception prices,” says Korrynn Baltzersen, head of wealth at deposit consultancy Curinos.
But there are indications that some rates are starting to fall.
Of the 500 Curinos tracks of U.S. banks, 78% of institutions that priced CDs above 4.00% have cut their rates since the Fed’s September 18 rate cut.
Of the lenders that had priced savings and money market deposits above 4.00%, 50% have also reduced their interest rates, according to Curinos.
‘These high rates have worn out their welcome a bit’
The lenders that will benefit most from the drop in these deposit rates are the smaller regional banks that saw their financing costs rise after the collapse of Silicon Valley Bank and several other large institutions in 2023.
For these lenders, there will be “a bit of a reversal” as rates fall, said Chris McGratty, head of U.S. banking research at KBW.
Based on an analysis by KBW, profit growth at major regional lenders is expected to catch up to that of larger peers in the coming year, while small and mid-sized banks should also see a boost.
“Rate cuts are more positive for mid-cap banks,” Morgan Stanley’s Grasek said in a note last week.
According to Morgan Stanley’s analysis, Keycorp (KEY) and PNC (PNC) are among the companies that will benefit the most.
But many investors are still willing to bet that lower interest rates could ultimately be a good thing for the entire banking industry, especially if the U.S. economy avoids a recession and lenders can avoid big losses on bad loans.
The easing of monetary policy could lead to more dealmaking, helping banks with large investment banking operations, while also boosting demand for new loans from consumers and businesses.
“We’re looking at an interest rate scenario here that will be good for the banks and good for the market,” Stephen Biggar, director of Argus Research, told Yahoo Finance.
“These high rates have somewhat worn out their welcome.”
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto and other financial areas.
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