Traders work on the floor at the New York Stock Exchange in New York City, US, February 7, 2024.
Brendan McDiarmid | Reuters
The benefits of scale will never be more evident than when banks start reporting their quarterly results on Friday.
Since the chaos of last year's regional banking crisis that consumed three institutions, larger banks have mostly performed better than smaller ones. This trend is expected to continue, especially since expectations about the size of interest rate cuts by the Federal Reserve have declined sharply since the beginning of the year.
The evolving picture for interest rates – dubbed “higher for longer” with expectations for rate cuts this year shifting from six cuts to perhaps three – will boost revenues for big banks while squeezing many smaller banks, adding to the group's concerns. According to analysts and investors.
C. B. Morgan Chasethe country's largest bank, begins industry earnings on Friday, followed by… American bank And Goldman Sachs next week. on monday, M&T Bank published the results, one of the first regional lenders to report for this period.
The focus for all of them will be how the changing view on interest rates will impact financing costs and holdings of commercial real estate loans.
“There are a few banks that have done a very good job of managing the interest rate cycle, and there have been a lot of banks that have mismanaged it,” said Christopher McGroty, head of U.S. banking research at KBW.
Pricing pressure
Take for example, Valley Bank, a regional bank headquartered in Wayne, New Jersey. Guidance given by the bank in January included expectations of seven interest rate cuts this year, which would allow it to pay lower interest rates to depositors.
Instead, the bank may be forced to lower its net interest income forecast if the cuts do not materialize, according to Bloomberg. Morgan Stanley Analyst Manan Gosalia, who has the equivalent of a sell rating on the company.
Net interest income is the money generated by a bank's loans and securities, minus what it pays for deposits.
Smaller banks have been forced to pay more for deposits than larger banks, which are seen as safer, following the failure of Silicon Valley Bank last year. The interest rate cuts would have provided some relief to smaller banks, while also helping commercial real estate borrowers and their lenders.
Valley Bank faces “greater deposit pricing pressure than peers if interest rates remain high for longer” and has greater exposure to commercial real estate than other regional areas, Gosalia said in an April 4 note.
Meanwhile, for big banks like JPMorgan, higher rates generally mean they can exploit their financing advantages for longer. They enjoy the benefits of earning higher interest on things like credit card loans and investments made during a period of rising rates, while generally paying lower interest rates on 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 diversified revenue streams than smaller banks in areas such as wealth management and investment banking. Both should provide a boost to first-quarter results, thanks to buoyant markets and a rebound in Wall Street activity.
Cre exposure
Furthermore, larger banks tend to have much less exposure to commercial real estate than smaller players, and generally have higher levels of provisions for loan losses, thanks to stricter regulations on the group.
This difference could be crucial this earnings season.
Concerns about commercial real estate, especially office buildings and multifamily housing, have weighed on small banks ever since Community Bank of New York It surprised investors in January with disclosures of significantly larger loan provisions and broader operational challenges. The bank needed a lifeline of more than $1 billion last month to help stabilize the company.
New York Commercial Bank will likely have to lower its net interest income guidance due to shrinking deposits and margins, according to JPMorgan analyst Stephen Alexopoulos.
There is a record $929 billion in commercial real estate loans outstanding this year, and about a third of the loans are for more money than the value of the underlying properties, according to consulting firm Newmark.
“I don't think we're out of the woods in terms of commercial real estate rearing its ugly head to bank profits, especially if interest rates stay high for longer,” said Matt Stuckey, equity portfolio manager at Northwestern Mutual.
“If there are a few issues around the credit experience with your commercial lending operation, as was the case with New York Commercial Bank, I've seen how quickly that can get away from you,” he said.
