The largest U.S. banks weathered a punishing first half largely unscathed. Now they just need to prove they can overcome a surge in expenses, regulatory changes and pricier deposits.
JPMorgan Chase, Citigroup and Wells Fargo are set to report second-quarter results Friday, followed by other industry heavyweights next week. Their expenses will be under scrutiny as the industry thins out its ranks to cope with a slowdown in deals and pays more to hold on to deposits as interest rates rise. Those headwinds are likely to push on net interest income, a big source of revenue.
Looming over all that are questions about how much more capital banks will have to set aside to please regulators following the collapse of four regional lenders earlier this year. That has implications for dividends and buybacks.
"There's no escaping the pressure from higher-for-longer interest rates," said Mike Mayo, an analyst at Wells Fargo. "Few expected rates to be this high, this fast, this long, and funding pressures are simply forcing repricing of deposits faster and sooner than the pricing of securities and loans."
Investors will also be scrutinizing results from regional banks, which are in the spotlight after aggressive rate hikes by the Federal Reserve led to the failure of Silicon Valley Bank, Signature Bank and First Republic Bank in quick succession earlier this year. Of particular concern is the quality and cost of funding sources, as deposit outflows force regional lenders to rely more on borrowing from the Federal Home Loan Bank system and flightier brokered and reciprocal deposits.
Here are some of the key figures analysts will be watching as results get underway:
Interest expenses
The most closely watched revenue figure is net interest income — how much banks generate on interest-bearing assets such as loans after subtracting the cost of interest-bearing liabilities like deposits.
Though the industry typically benefits from higher borrowing costs, the aggressive pace of rate hikes by the Fed has forced firms to shell out more to depositors while doing little to boost the profitability of their existing loan portfolio.
For the six largest U.S. banks, interest expenses are set to climb to roughly $78.7 billion from $15.5 billion in the same period last year, according to analyst estimates compiled by Bloomberg. But net interest income is expected to increase at a far slower pace, rising to only about $65 billion from $54 billion.
The results for second-quarter net interest income probably matter less than what the company says about the outlook for the future, KBW analyst David Konrad said. "If managements hold their NII outlook for the year, that's big," he said.
One possible cause for less alarm than expected is credit. Though net charge-offs — the amount banks expect to lose on soured loans — will probably creep higher, the increase is expected to be small.
"Credit outside of subprime consumer is the bright spot," Morgan Stanley analysts led by Betsy Graseck said in a note to clients. "It's a double-edged sword because the good news is credit is good, but the bad news is that this could mean rates need to go even higher."
Headcount costs
A dealmaking slump and stagnant capital markets have led to staff reductions throughout Wall Street. Though those cuts will help moderate costs over time, they will probably cloud the expense picture in the short term.
Citigroup Chief Financial Officer Mark Mason warned investors last month that the bank expects to record severance costs linked to the departure of 1,600 employees in the second quarter, which could push expenses higher by as much as $400 million compared with the first three months of the year.
Citigroup, Goldman Sachs Group and Morgan Stanley have embarked on some of the most dramatic cuts in the past year, mulling over or following through on thousands of reductions.
About 125 Goldman managing directors will lose their jobs, in the firm's third round of job cuts in less than a year, Bloomberg News reported last month. Separately, senior managers at Morgan Stanley have discussed plans to eliminate 3,000 jobs by the end of the second quarter.
"The banks could have egg on their face either way," Mayo said. "Reduce headcount now and slightly miss out on the recovery, or fail to reduce headcount now and be criticized for lack of financial discipline."
Regulatory charges
Banks may also experience pressure from forthcoming regulatory changes.
The Federal Deposit Insurance Corporation is set to level a special assessment after its aid to Silicon Valley Bank, Signature Bank and First Republic Bank depositors tapped its bedrock insurance fund. The fees, which will replenish the fund the regulator uses to resolve failed lenders, will be calibrated to benefit primarily the largest banks, according to the agency.
Higher capital requirements linked to international standards known as Basel III also loom large. Fed Vice Chair for Supervision Michael Barr said in a speech on Monday that the shift to Basel III would primarily affect the "largest, most complex banks." Many lenders already have enough capital to meet the new requirements, Barr said, meaning there may not be an immediate cost associated with the proposed rules. Still, higher requirements present a further constraint on capital that the industry has long resisted.
"Clearly there's an upward bias to capital ratios, which all else equal will pressure returns," Jason Goldberg, an analyst at Barclays, said. "One of the things we'll be listening to is how banks expect to adapt to the evolving regulatory landscape."
