Rate cuts may impact big banks more negatively than regionals, analyst says

Interest-rate cuts by the Federal Reserve may have a greater negative impact on big banks due to their higher asset sensitivity, unlike the regionals which are more neutral to short-term, policy-sensitive rates, Jefferies wrote in a recent note to clients.

Gathering forward-looking guidance from Q2 2024 earnings, analyst Ken Usdin noted the bulk of lenders within his coverage are expecting annual growth in net interest income – the profit banks make when the interest earned from loans and investments exceed the interest paid on deposits and other borrowings.

“While loan growth has been weaker-than-expected, deposit balances and pricing have been better as offsets, which led most banks to reiterate NII guides,” the Tuesday note said. Banks generally assumed one to two rate reductions in 2024, trailing current market expectations of about five cuts.

Universal banks, such as Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC) and JPMorgan Chase (NYSE:JPM), are broadly asset-sensitive to the short-end of the Treasury yield curve (US2Y), while their regional counterparts are “asset-sensitive to the belly (US5Y) and long-end (US10Y) (US30Y) of the curve given fixed-rate asset repricing dynamics,” Usdin noted.

The analyst contended that the recent retreat in Treasury yields – dragged down by a softer macroeconomic outlook – could bode poorly for NIIs in the back half of 2024 through 2025. “As an offset, lower-than-expected earning asset yields could be neutralized by faster downside deposit betas and a return to volume growth.”

Deposit betas gauge how changes in benchmark rates affect banks’ deposit rates. It’s the percentage of changes in market rates that banks have to pass onto their customers. For example, if market rates rise by 1% and deposit rates rise by 0.6%, the deposit beta would be 0.6.

Within the large-cap regionals sub-group, third-quarter NII is expected to decline Q/Q for Comerica (NYSE:CMA) and Citizens Financial Group (NYSE:CFG). On a full-year basis, NII is seen declining at Comerica (CMA), Fifth Third Bancorp (NASDAQ:FITB), Huntington Bancshares (NASDAQ:HBAN), KeyCorp (NYSE:KEY) and Truist Financial (NYSE:TFC).

Note that Fifth Third (FITB), Truist (TFC), PNC Financial Services Group (NYSE:PNC), Regions Financial (NYSE:RF) and Huntington (HBAN) all are expecting NII to rise Q/Q in Q3. Comerica (CMA) and Citizens Financial (CFG) anticipate a sequential increase in Q4.

The universal banks expecting a dip in 2024 NII include Bank of America (BAC), Citigroup (NYSE:C) and Wells Fargo (WFC). Among the trust banks, BNY Mellon (NYSE:BK) expects a 10% decline in 2024 NII, while State Street (NYSE:STT) sees the profitability measure rising slightly from a year earlier.

HSBC analyst Saul Martinez thinks regional banks’ Q2 earnings support the notion that NII has hit a positive turning point, with the potential for sequential growth in the second half of 2024. “Improved NII in 2H24 is critical for many banks to deliver on generating positive operating leverage and double-digit EPS growth in 2025,” he wrote in an Aug. 4 note.

Similarly, Morgan Stanley’s Manan Gosalia has become more confident that midcap banks’ NII is at an inflection point after reviewing Q2 results. “This will initially be driven by improving net interest margins as banks can quickly cut deposit costs,” the analyst wrote in a note, adding “an acceleration in industry-wide loan growth in 2025 should be an incremental tailwind.”

What the execs are saying

Still, banks broadly ended Q2 on a positive footing. For example, U.S. Bancorp’s (NYSE:USB) Q2 NII was bolstered by a “combination of deposit volume growth, pricing stabilization, and slower migration as well as fixed asset repricing, improved loan mix, and other actions taken on the investment portfolio to optimize cash balances,” Senior Executive Vice President and CFO John Stern had said during the company’s earnings conference call.

BofA’s (BAC) NII, meanwhile, slipped from Q1, which management said was driven by “higher funding costs and the rotation of deposits seeking higher yield alternatives.”

Wells Fargo (WFC), too, saw a Q/Q decline in NII, but CEO Charlie Scharf said that was more than offset by an increase in noninterest income.