High interest rates put pressure on small players

The economies of scale will never be more apparent than when banks start reporting quarterly results on Friday.

Since the chaos of last year’s regional banking crisis, which consumed three institutions, larger banks have tended to outperform smaller ones. This trend is expected to continue, especially as expectations about the size of Federal Reserve rate cuts have fallen sharply since the start of the year.

The evolving picture of interest rates – dubbed ‘higher for longer’ as expectations for rate cuts this year shift from six to perhaps three cuts – will boost revenues for big banks, while putting pressure on many smaller banks, which will increase the concerns for the group. , according to analysts and investors.

JPMorgan Chasethe country’s largest lender, kicks off industry earnings results on friday, followed by bank of America And Goldman Sachs next week. On Monday, M&T Bank is achieving results, one of the first regional lenders to report this period.

The focus for all of them will be on how the changing view of interest rates will impact the cost of financing and holding commercial real estate loans.

“There have been a handful of banks that have managed the interest rate cycle very well, and there have been a lot of banks that have managed it poorly,” he said. Christopher McGrattyhead of US banking research at KBW.

Take for example Valley Bank, a regional lender based in Wayne, New Jersey. The bank’s guidance in January included expectations for seven interest rate cuts this year, which would have allowed it to pay lower interest rates to savers.

Instead, the bank could be forced to lower its net interest income outlook as cuts fail to materialize. 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 the bank pays for deposits.

Smaller banks have been forced to pay more for deposits than larger ones, considered safer, in the wake of Silicon Valley Bank’s collapse last year. Rate cuts would have provided some relief to smaller banks, while also helping commercial real estate borrowers and their lenders.

Valley Bank faces “more pressure on deposit prices than peers if rates remain higher for longer” and has more exposure to commercial real estate than other regions, Gosalia said in an April 4 note.

Meanwhile, for big banks like JPMorgan, higher interest rates generally mean they can enjoy their financing benefits for longer. They enjoy the benefits of higher interest rates on things like credit card loans and investments made during a time of higher interest rates, while generally paying low interest rates on deposits.

JPMorgan could raise its 2024 net interest income expectations 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 banks from areas such as wealth management and investment banking. Both should boost first-quarter results, thanks to buoyant markets and a recovery in Wall Street activity.

In addition, large banks tend to have much lower exposure to commercial real estate than smaller players, and generally have higher loan loss provisions, thanks to stricter group regulations.

That difference could be crucial this earnings season.

Concerns about commercial real estate, especially office buildings and multifamily properties, have haunted smaller banks ever since Community Bank of New York stunned investors in January with revelations of dramatically increased loan provisions and broader operational challenges. The bank needed a lifeline of more than $1 billion last month to keep the business stable.

NYCB will likely have to lower its net interest income expectations due to shrinking deposits and margins, JPMorgan analyst Steven Alexopoulos said.

A record $929 billion in commercial real estate loans will come due this year, and roughly a third of the loans have a higher value than the underlying real estate values, according to consultancy Newmark.

“I don’t think we’re out of the woods when it comes to commercial real estate taking over bank profits, especially if rates stay higher for longer,” said Matt Stucky, chief portfolio manager for equities at Northwestern Mutual.

“If there’s even a hint of trouble around the lending experience with your commercial lending, as was the case with NYCB, you’ve seen how quickly that can get away from you,” he said.