Traders work on the ground on the Recent York Stock Exchange (NYSE) in Recent York City, U.S., February 7, 2024.
Brendan Mcdermid | Reuters
The advantages of scale won’t ever be more obvious than when banks begin reporting quarterly results on Friday.
Ever for the reason that chaos of last yr’s regional banking crisis that consumed three institutions, larger banks have mostly fared higher than smaller ones. That trend is set to proceed, especially as expectations for the magnitude of Federal Reserve interest rates cuts have fallen sharply for the reason that start of the yr.
The evolving picture on interest rates — dubbed “higher for longer” as expectations for rate cuts this yr shift from six reductions to perhaps three – will boost revenue for giant banks while squeezing many smaller ones, adding to concerns for the group, according to analysts and investors.
JPMorgan Chase, the nation’s largest lender, kicks off earnings for the industry on Friday, followed by Bank of America and Goldman Sachs next week. On Monday, M&T Bank posts results, one among the primary regional lenders to report this era.
The main target for all of them might be how the shifting view on interest rates will impact funding costs and holdings of business real estate loans.
“There is a handful of banks which have done a superb job managing the speed cycle, and there is been a whole lot of banks which have mismanaged it,” said Christopher McGratty, head of U.S. bank research at KBW.
Pricing pressure
Take, as an example, Valley Bank, a regional lender based in Wayne, Recent Jersey. Guidance the bank gave in January included expectations for seven rate cuts this yr, which might’ve allowed it to pay lower rates to depositors.
As an alternative, the bank could be forced to slash its outlook for net interest income as cuts don’t materialize, according to Morgan Stanley analyst Manan Gosalia, who has the equivalent of a sell rating on the firm.
Net interest income is the cash generated by a bank’s loans and securities, minus what it pays for deposits.
Smaller banks have been forced to pay up for deposits more so than larger ones, that are perceived to be safer, within the aftermath of the Silicon Valley Bank failure last yr. Rate cuts would’ve provided some relief for smaller banks, while also helping business real estate borrowers and their lenders.
Valley Bank faces “more deposit pricing pressure than peers if rates stay higher for longer” and has more business real estate exposure than other regionals, Gosalia said in an April 4 note.
Meanwhile, for big banks like JPMorgan, higher rates generally mean they will exploit their funding benefits for longer. They enjoy the advantages of reaping higher interest for things like bank card loans and investments made during a time of elevated rates, while generally paying low rates for deposits.
JPMorgan could raise its 2024 guidance for net interest income by an estimated $2 billion to $3 billion, to $93 billion, according to UBS analyst Erika Najarian.
Large U.S. banks also tend to have more diverse revenue streams than smaller ones from areas like wealth management and investment banking. Each should provide boosts to first-quarter results, thanks to buoyant markets and a rebound in Wall Street activity.
CRE exposure
Moreover, big banks tend to have much lower exposure to business real estate compared with smaller players, and have generally higher levels of provisions for loan losses, thanks to tougher regulations on the group.
That difference could prove critical this earnings season.
Concerns over business real estate, especially office buildings and multifamily dwellings, have dogged smaller banks since Recent York Community Bank stunned investors in January with its disclosures of drastically larger loan provisions and broader operational challenges. The bank needed a $1 billion-plus lifeline last month to help regular the firm.
NYCB will likely have to cut its net interest income guidance due to shrinking deposits and margins, according to JPMorgan analyst Steven Alexopoulos.
There may be a record $929 billion in business real estate loans coming due this yr, and roughly one-third of the loans are for extra money than the underlying property values, according to advisory firm Newmark.
“I do not think we’re out of the woods by way of business real estate rearing its ugly head for bank earnings, especially if rates stay higher for longer,” said Matt Stucky, chief portfolio manager for equities at Northwestern Mutual.
“If there’s even a whiff of problems across the credit experience along with your business lending operation, as was the case with NYCB, you’ve got seen how quickly that may get away from you,” he said.