Interest rates

Bank earnings to shine a light on rising interest rates – and costs

Interest rates are on the rise and should continue to rise, bolstering bank lending profitability and providing timely support for earnings.

But rising rates may not be enough to offset cost pressures or lower fee income – or the shrinking benefit from loan loss reserve releases.

First-quarter earnings, to be released in April, will provide the first glimpse of the year into banks’ ability to navigate a rapidly changing landscape amid Federal Reserve policy shifts and Russia’s invasion of lending. Ukraine who already intense inflationary pressures amplified.

Fed policymakers raised their benchmark rate in March and expect several more hikes this year. They are raising rates to rein in spending and dampen inflation, but with that change comes the risk of going too far and pushing the economy into recession. The war adds to this concern, given the risk of Russian aggression spilling over the borders of Ukraine and causing greater global economic turmoil.

“There are suddenly uncertainties on top of uncertainties,” said Mike Matousek, chief trader at US Global Investors. “And we still have the pandemic with us too.”

Indeed, after the drop in coronavirus cases in 2021 and at the beginning of this year, cases are increasing in Western Europe and China, forcing new containment measures to slow the spread of the virus. These include tough new mobility rules in Shanghai, China’s largest city with more than 25 million people. The challenges abroad remind American bankers of the potential for a new epidemic here.

Piper Sandler analysts forecast banks would collectively post 6% loan growth in a quarter tied with their first-quarter results, reflecting the strength of a growing U.S. economy and pent-up trade demand for loans to fund projects. expansion projects. With rates exceptionally low until Fed action in mid-March, analysts predict banks will earn net interest margins remained under pressure during the quarter – flat to slightly lower – but they look for improvement as short-term rates rise through 2022 in line with Fed hikes.

However, with stock prices struggling in 2022, Piper Sandler expects wealth management and capital markets revenue to decline. Analysts also expect mortgage costs to fall, as tight housing supply and soaring prices have dampened home buying activity – while long-term rates, already on the rise in beginning of this year, decreased demand for refinancing. In total, they expect commission revenue to decline 2% from the prior quarter.

Suddenly there are uncertainties on top of uncertainties. And we still have the pandemic with us too.

Mike Matousek, Chief Trader at US Global Investors

Also, when comparing to prior periods, first quarter results could suffer due to last year’s temporary gains. After bolstering their reserves to cover potential loan losses in 2020 – fearing a prolonged recession amid the first wave of the pandemic – banks reversed course in 2021. The economy unexpectedly rebounded last year and the banks collectively released nearly $60 billion in reserves during the year. , strengthening their results, according to S&P Global. There’s little left to release this year, though.

At the same time, Piper Sandler’s team notes, costs continue to rise alongside inflation that hit a 40-year high in February. Analysts expect first-quarter spending across the industry to rise 1.5% quarter-on-quarter and 7% year-over-year.

Conclusion: Analysts expect first-quarter earnings per share in Piper Sandler’s coverage universe to fall 13% from the prior quarter.

The rest of the year may not be better off.

“2022 was expected to be a banner year for banks, given a strong economy and the prospect of measured rate increases,” Piper Sandler analyst Brad Milsaps said. “But as we sit here today, there is fear of something negative around every corner, and with inflation where it is, we could get a much faster pace of rate increases. quicker than we thought.”

Earlier this year, Milsaps and his colleagues forecast three rate hikes in 2022 — they now expect seven, Milsaps said. While the rapid rise in rates should prove bullish for banks’ loan portfolios, it could also present potential headwinds for credit quality, he said.

Wedbush analysts agreed. Over the past 35 years, the Fed has staged five rounds of rate tightening and the US economy has gone into recession four of those times, they said. Loan losses tend to accumulate when the economy falters.

“Uncertainty has crept into the outlook for the fallout from the Russian invasion of Ukraine, leading to higher inflationary pressures and a higher risk of recession,” Wedbush analysts said in a report.

Scott Brown, Raymond James’ chief economist, painted a similar picture.

“Of course, the Fed could end up tightening policy less aggressively,” he noted, but that would only happen because the economy is slowing for other reasons. Either way, he said, the risk of a recession is growing.

Almost across the board, bankers remain optimistic as they prepare to report earnings, according to Milsaps. But if the specter of recession intensifies, concerns about threats to credit quality will inevitably increase.

An economic crisis “would have repercussions everywhere,” Milsaps said.