- Higher interest rates are expected to lead to an increase in losses in banks’ bond portfolios and contribute to funding pressures as institutions are forced to pay higher interest rates on deposits.
- KBW analysts Christopher McGratty and David Konrad estimate that banks’ earnings per share fell 18% in the third quarter as loan margins fell and loan demand fell due to higher borrowing costs.
- Earnings season begins Friday with reports from JPMorgan Chase, Citigroup and Wells Fargo.
Jamie Dimon, Chairman and Chief Executive Officer of JPMorgan Chase & Co. gestures as he speaks during an interview with Portal in Miami, Florida, United States, February 8, 2023.
Marco Bello | Portal
American banks are capping off another quarter in which interest rates rose sharply, rekindling concerns about falling margins and rising loan losses – although some analysts see a silver lining to the industry’s woes.
Just as during the regional banking crisis in March, higher interest rates are expected to lead to a rise in losses in banks’ bond portfolios and contribute to funding pressures as institutions are forced to pay higher interest rates on deposits.
KBW analysts Christopher McGratty and David Konrad estimate that banks’ earnings per share fell 18% in the third quarter as loan margins fell and loan demand fell due to higher borrowing costs.
“The fundamental outlook is difficult in the near term; sales are down, margins are down, growth is slowing,” McGratty said in a phone interview.
Earnings season begins Friday with reports from JPMorgan Chase, Citigroup and Wells Fargo.
Bank stocks have been closely linked to borrowing cost trends this year. The S&P 500 Banks Index fell 9.3% in September on concerns sparked by a surprise rise in longer-term interest rates, particularly the 10-year yield, which rose 74 basis points in the quarter.
Rising yields cause banks’ bonds to fall in value, resulting in unrealized losses that put pressure on capital. The dynamic caught mid-sized institutions like Silicon Valley Bank and First Republic by surprise earlier this year, which — along with the deposit rush — led to the government’s seizure of those banks.
Major banks have largely sidestepped concerns about underwater bonds, with the exception of Bank of America. The bank invested heavily in low-yielding securities during the pandemic and posted paper losses on bonds worth more than $100 billion by mid-year. The issuance limits the bank’s interest income and has made the lender one of the worst-performing stocks among the six largest U.S. institutions this year.
Expectations about the impact of higher interest rates on banks’ balance sheets varied. Morgan Stanley analysts led by Betsy Graseck said in an Oct. 2 note that the “estimated impact of the bond crisis in the third quarter is more than double” the losses in the second quarter.
Bond losses will have the biggest impact on regional lenders such as Comerica, Fifth Third Bank and KeyBank, Morgan Stanley analysts said.
But others, including KBW and UBS analysts, said other factors could ease the capital burden of higher interest rates for most of the industry.
“A lot will depend on the duration of their books,” Konrad said in an interview, referring to the question of whether banks held bonds with shorter or longer durations. “I think bond valuations will be similar to last quarter, which is still a headwind for capital, but that there will be a smaller group of banks that will be more impacted because of their ownership.”
There is also concern that higher interest rates will lead to skyrocketing losses in commercial real estate and industrial loans.
“We expect loan loss provisions to increase significantly compared to the third quarter of 2022 as we expect banks to build loan loss reserves,” RBC analyst Gerard Cassidy wrote in an Oct. 2 note.
Still, bank stocks are primed for a short squeeze during earnings season as hedge funds have bet on a return to the chaos of March, when regional banks experienced an outflow of deposits, UBS analyst Erika Najarian wrote in an Oct. 9 note.
“The combination of short interest above March 2023 levels and macro investors’ short thesis that higher interest rates will trigger another liquidity crisis leads us to believe the sector is primed for a potentially volatile short squeeze,” Najarian wrote.
Banks are expected to have stable deposits in the quarter, according to Goldman Sachs analysts led by Richard Ramsden. That and forecasts for net interest income in the fourth quarter and beyond could support some banks, said analysts, who are bullish on JPMorgan and Wells Fargo.
Perhaps because bank stocks have come under so much pressure and expectations are low, the industry is poised for a recovery rally, McGratty said.
“People are looking ahead: Where is the bottom in revenue?” McGratty said. “If you think about the last nine months, the first quarter was really tough. The second quarter was challenging but not as bad, and the third will still be tough, but again it won’t get any worse.”