U.S. bank earnings preview: What to watch

We're about a week away from the kickoff to another US bank earnings season. How is the sector faring in this environment? Joining us now to discuss, Stephen Biggar, Director of Financial Institutions Research at Argus Research. Stephen, great to have you back on the show. Let's talk banks. Let's talk about how the sector is doing.

Yeah. Hi, Greg. Good to be back. So, well, we're a bit better of a start in 2024 than we were in 2023, that's for sure. The 500 was up 24% last year. Financials were only up 10%. And those regional banks just had a really tough year, down 26%.

There was just a host of problems. last March, of course, we had the Silicon Valley Bank failure. We had a lot of concerns about just deposit outflows. We had some questions about regulation throughout the year, and then, of course, we had some rising delinquencies and charge-offs. So that kind of really put a damper on the group. But this year, a little bit better.

The S&P is up 10 through the first quarter, financials up 12-- they're actually beating. Regional banks are up 7. So they're kind of holding their own. And I think people are taking a fresh look at banks so far this year.

Yeah. So it's an interesting time, as you said, compared to last year. Let's start breaking down some of the lines of business. In this environment, it looks like so far the pundits are convinced, or at least feeling comfortable with, the no-recession scenario. So what does loan growth look like in this environment?

Yeah. Well, that's very important for banks, obviously, this no-recession scenario. They don't fare very well in downturns-- of course, very deep downturns. They're cyclical plays.

Loan growth has slowed. It's been very anemic. And that's kind of what the Fed is doing. They've raised interest rates quite a bit here. And that has slowed loan growth. So loan demand is really just down to a trickle.

So we're hoping by the end of this year, if we do get some pullback on interest rates, that we'll get a little bit better loan growth. And some segments are doing a little bit better than others. Housing is not doing very well. Obviously, there's not a lot of turnover-- mortgage banking business not doing well for banks.

You still have a fair amount of credit card, lending which is actually not a great thing for consumers because it's very high interest rate loans. But that has been a source of loan growth for banks.

All right, so they're starting to see some signs there that, perhaps, things will pick up. You said, of course, so much of everything depends on the Fed right now. When I think about banking, it can be such a complicated business.

And it is, but at it's heart, it's those net interest margins, right? The deposits you're taking in, what are you getting in terms of the loans? What is the state of net interest margins right now?

Yes. Well, margins have been improving over the course of the past year. And most of that, of course, is the yield on interest rates, right? And banks are kind of naturally interest rate-sensitive or asset sensitive-- which means basically their lending book reprices faster to interest rates than the funding or deposit book.

So higher interest rates or rising rates are generally beneficial. There's been some offset with rising deposit costs, of course. And frankly, we think net interest margins here have probably peaked for this cycle. They tend to get some benefit from the year-over-year situation.

But I think quarter-over-quarter now, the sequential quarters, we're about at a peak at this point. Ironically, however, though, again, at this point in the cycle, it tends to be where loan demand starts to get hurt where lower rates will actually start to be more beneficial for banks. If it stimulates, again, loan growth a little bit stronger here, and banks can still take advantage of I would say relatively high interest rates, because kind of in the year or two after the pandemic, rates were just rock bottom.

And those interest margins are just getting killed. So we're at a better place in net interest margins. We just don't expect additional expansion from here.

Now, you talked about, obviously, that the Fed and what it gets up to this year is going to be pretty important. The market is anticipating cuts. Even the Fed themselves saying, we will be in a position to cut. But they're preaching patience. It seems that they're sort of putting us off of our expectations of an imminent cut.

What could that all mean for the banks? you talked about delinquencies earlier, right? If rates stay at this level for much longer, can the consumer hold out?

Well, that's the wild card. And I think that's why banks have done better when interest rates are kind of pulling off the peak here, because, sure, it makes it difficult to refinance. That's a problem for homeowners that have adjustable rate mortgages.

Now, a lot of customers have fixed rate, and they haven't been hurt by the higher rates. But some have adjustable. It also hurts on the new purchases. Anybody taking out a mortgage loan today, very, very high, and those refinancing.

So sometimes you have, particularly business loans, that are coming due-- and in the office property market, in particular, for commercial real estate. So that has put a damper. Where the real kind of degradation in credit quality has been lately has been on the consumer side, and particularly the credit card space, as I mentioned.

Auto loans have moved up, but not quite as far. So it really indicates to us that the lower income consumer, the folks that kind of use credit cards to get from paycheck to paycheck, and just the rising cost of living that inflation has produced for, really, just basic goods, things you can't do without-- food, housing, clothing, and utilities, that sort of thing-- have really put lower income consumers in a bind. So we're watching these credit card delinquencies, in particular, very closely.

All right, so that will be important as the earnings season comes up on us. We're always looking at loan loss provisions, delinquencies. What else are you going to be watching for this earnings season when it comes to the big banks?

Well, of course, the big swing factor for the large banks would be the capital markets segment. So there's a lot of crosscurrents in that space. I think that'll be one of the largest ones. Commentary about the office market, particularly for the regional banks-- it's a smaller proportion for the large global banks. So that clearly is going to be a question mark for bank managements.

And also, deposit flows-- that has, again, a year ago, was a big concern. Clearly as the rest of '24 went on, that became less of a concern. But it's still important. It's a very important source of financing for banks. And we'll be listening intently to what the deposit betas are.

That's how much banks have had to increase deposits in order to retain, or how much they've increased relative to, say, the Fed funds rate or other interest rates. And so how they're going about, basically, retaining the solid deposit base that they need to fund their loans.

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