Rate reductions can worsen the situation for banks before they get better
Given the potential interest rate cuts by the Federal Reserve, banks are likely to see positive outcomes. However, not immediately.
The largest banks are beginning to feel the impact of high interest rates, as deposit costs increase and customers, such as credit-card and commercial-property borrowers, are starting to experience the consequences of higher debt payments.
In the end, banks can benefit from lower but still relatively high interest rates. Rate cuts have the potential to boost borrowing and incentivize dealmaking on Wall Street. Additionally, they can assist banks in reducing the rates they offer on products such as high-yield savings accounts or certificates of deposit. If the Federal Reserve ultimately decides to only reduce interest rates a few times and doesn’t go back to the extremely low rates seen in previous economic cycles, it would likely contribute to maintaining strong overall interest earnings for banks.
However, the shift to that world may encounter some challenges. A modest decrease in interest rates is unlikely to single-handedly spur a significant increase in lending. However, this will gradually reduce banks’ interest earnings on their cash and on floating-rate loans linked to benchmark rates, such as credit cards or corporate revolvers. Many depositors will likely continue to seek a favorable return on their cash.
(Image: WSJ)
Take a look at the complete image. (Image: WSJ)
When Wells Fargo released its second-quarter earnings on Friday, it stated that it anticipates a decrease in net interest income for this year, projecting a decline of approximately 8% to 9%. This outlook is slightly more cautious than its previous estimate of a decline ranging from around 7% to 9%. This measure is closely monitored to assess the net interest earnings of banks, taking into account the interest they earn and the interest they pay out.
Identifying the specific quarter that will mark the lowest point for net interest income can be a bit challenging, according to Wells Fargo Chief Financial Officer Michael Santomassimo during a recent discussion with analysts. However, he expressed optimism about the possibility of witnessing this in the next few quarters.
Wells, Citigroup, and JPMorgan Chase all experienced a decline in their reported net interest margin for another quarter. This metric measures the difference between the rates banks earn on assets and what they pay on liabilities.
If banks focus on expanding their loan books, they can increase their overall earnings and avoid being squeezed. However, large corporate borrowers continue to exercise caution. When it comes to commercial real-estate loans, certain banks might be seeking to reduce their loan portfolios at the moment. They are optimistic that construction projects will secure long-term financing from other sources or that borrowers will increase their equity and opt for smaller loans during refinancing.
Consumer lending through credit cards continues to experience robust growth. However, concerns regarding consumer behavior suggest that now may not be the most opportune moment to excessively indulge in credit card spending. In the second quarter, there was a significant increase in banks’ net charge-off rates on card loans compared to the previous year.
Banks contend that the increase in losses is partially attributed to the unusually strong credit performance observed during the pandemic. Furthermore, there was a noticeable deceleration in delinquency rates from one quarter to the next. However, it may still require a few quarters to navigate through the challenge of losses and for the positive impact of reduced monthly payments to be reflected in borrowers’ financial plans.
Lower interest rates should eventually alleviate the pressure on banks’ increasing deposit costs. However, many customers have been slow to withdraw cash from checking accounts, even if rates have slightly decreased. This could result in banks facing higher interest costs. Given the current state of longer-term bond yields and individuals’ investment and spending preferences, it is possible that people may choose to keep their cash untouched for an extended period to maximize their earnings.
As an economist would say, Wells Fargo’s Santomassimo informed analysts on Friday that the rate of growth in deposit costs had decelerated during the first half of the year. However, it is worth mentioning that the bank recently increased the pricing on sweep deposits in advisory brokerage accounts. This adjustment was not expected based on the bank’s initial net interest income guidance.
There are additional factors at play that could potentially benefit large financial institutions. Another increase in Wall Street dealmaking has the potential to generate additional fee income. When interest rates decline, it can have a positive impact on banks’ securities portfolios, leading to an increase in capital. Additionally, as regulators reconsider their plans to raise banks’ capital requirements, it is possible that the largest lenders may find themselves with a surplus of resources.
However, for those resources to be effectively utilized, it may be necessary to wait for additional rate cuts to stimulate stronger economic activity. Currently, it appears that bank stocks have come to a halt. Shares of Citigroup, JPMorgan, and Wells all experienced a decline on Friday. The KBW Nasdaq Bank index has seen a modest increase of over 13% this year, which falls slightly behind the S&P 500’s impressive rise of nearly 18%.
At times, the waiting can be quite challenging.
