Five areas to watch as banks report their Q3 earnings

October 10, 2024 1:15 PM

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Over the last two years, many banks' earnings have been plagued by a combination of elevated deposit costs and muted loan demand.

Those headaches are poised to subside — but perhaps not right away — following the Federal Reserve's decision last month to lower its benchmark interest rate. The 50 basis-point reduction was the first cut since the onset of the COVID-19 pandemic in March 2020.

Heading into the sector's third-quarter earnings season, which began Friday, all eyes will be on deposit costs, loan growth and, relatedly, net interest income, which is the difference between what banks collect on loans and what they pay for deposits.

JPMorgan Chase, Wells Fargo and Bank of New York Mellon were the first to deliver their results, followed this week by Citigroup, Bank of America, Goldman Sachs and other large and regional banks.

While analysts expect net interest income to improve eventually as a result of the Fed's pivot to rate cuts, they also anticipate that banks will report near-term pressure in that area. As rates start to come down, there will likely be a gap between the timing of when loans and deposits reprice, they argue.

"We think companies are very enthusiastic about the ability to reduce deposit costs and that they will do so very aggressively," Scott Siefers, an analyst at Piper Sandler, said in an interview.

But "the fear" is that banks "might have to take a step back" before they are able to "take a step forward," Siefers said.

"Overall, [net interest income] maybe takes a little hit before it starts to get better," he said.

Three other topics will also be on investors' minds this earnings season, according to analysts. Credit quality metrics, the capital markets business and the information that banks share about their fourth-quarter outlooks will be heavily monitored, they said.

Here's a closer look at five areas to watch as the latest earnings season kicks into gear.

Loan growth

The lack of loan growth has been a perpetual area of focus, as the recent rising interest rate environment has reduced borrowers' demand for credit.

While today's lower rates and the anticipation of further reductions should eventually increase demand, don't expect banks to report much loan growth for the third quarter, analysts agree.

"The story there is not so good, nor has it been for most of the year," Siefers said. "Some of the building blocks are in place, but we're not seeing [loan growth play out in results] yet."

"Tepid," "anemic" and "elusive" are some of the words that analysts used to describe loan growth in recent research notes.

Analysts at D.A. Davidson wrote that while they are expecting "a modest pickup" for the third quarter versus the second quarter, much of the talk about loan growth "remains fairly muted as borrowers are still on the sidelines," waiting for lower rates, more proof that a soft landing will happen and more clarity around the outcome of the November elections.

Next year could be a different story. For 2025, the D.A. Davidson analysts are forecasting loan growth of 6.5% across the banks they cover, noting that lending volume "should improve" as interest rates keep falling, election uncertainty eases and a recession is avoided.

In the near term, what may be important is not so much what banks report for the third quarter as what they say about the fourth quarter and beyond, Siefers said.

"Investors will 100% be looking for signs of an improving picture down the road," he said.

Deposit costs

Hand in hand with loan growth, the pace at which banks expect to reduce their deposit costs will be closely monitored. Some banks started trimming deposit yields earlier this year, ahead of the Fed's widely anticipated reduction, and now that lower rates are officially here, more banks are eager to reduce what they pay for deposits.

The question is: How quickly will they be able to do so? Some analysts said the answer might not be clear during third-quarter conference calls, since the Fed took action on Sept. 18, less than two weeks before the end of the three-month reporting period.

As a result of the timing, the 50-basis-point cut "is not likely to have a material impact" on third-quarter results, Vivek Juneja, an analyst at JPMorgan Securities, wrote in a research note.

Still, "banks are starting to see deposit costs crest," said Jason Goldberg, an analyst at Barclays who covers large banks. That's because "some of the constraints are maybe lifting."

Credit quality

Most analysts agree that banks will report continued weakening of credit quality, though credit metrics are still moving back toward normal levels after unusually strong loan performance during the pandemic.

Overall, credit quality is becoming less of a worry than it has been in recent quarters.

"Oddly or thankfully — pick your adverb — that seems to be becoming less of a concern for a lot of investors as the prevailing outcome becomes the notion of a soft landing or no landing at all," Siefers said. "That's not to say things won't deteriorate. We're still normalizing as an industry."

D.A. Davidson analysts expressed similar sentiments in their own research note. Most of the credit issues for the banks they follow have arisen in the commercial real estate segment, primarily in office loans and multifamily loans, as well as in some commercial and industrial loans, they said.

The potential for more rate cuts this year "should ease credit pressures and reinforce our investment call for [net charge-offs] to peak in early 2025," they wrote.

Capital markets

While banks' total fee income might be mixed in the third quarter — in part because mortgage volumes are still subdued in the higher rate environment — the capital markets business could prove to be a bright spot, some analysts said.

Specifically, the six largest commercial and investment banks — JPMorgan, Bank of America, Citi, Wells Fargo, Goldman Sachs and Morgan Stanley — are likely to report "strong trading revenue and an improvement in investment banking revenue" compared with the year-ago quarter, Moody's Ratings analysts said in a research note.

The capital markets business suffered during last year's slump in corporate mergers, but dealmaking is revving back up, which should boost activity in investment banking.

There was some turmoil this summer when global markets took a tumble. But by and large, commentary about third-quarter capital markets performance should be positive, Siefers said.

Wedbush Securities analysts wrote that "positive momentum appears to be forming, especially on the capital markets front." Meanwhile, Juneja wrote that "markets remain strong and optimistic, which is driving solid investment banking fees, the brightest spot for bank revenues."

Outlook for fourth quarter and 2025

Finally, what banks say, or don't say, about their fourth quarter expectations will be important.

The October-to-December period will be the first full quarter that includes the impact from the September rate cut, and the Fed could cut rates again in November and December.

"A big focus of the earnings season tends to be the full-year guidance," Goldberg said. "We will look to see if the evolving interest rate backdrop alters company views."

JPMorgan raised its guidance for full-year net interest income and full-year expenses. The company now projects net interest income will be about $92.5 billion for 2024, up from the forecast of $91 billion that it provided in July. Full-year expenses, excluding legal fees but including a special assessment by the Federal Deposit Insurance Corp. and a contribution to the firm's foundation, are now forecast to be $91.5 billion, about half a billion dollars less than what it laid out this summer.

Banks will likely offer guidance for the fourth quarter during their third-quarter conference earnings calls. But most of them won't divulge their expectations for 2025 before January.

So the question is, "what is the fourth quarter going to look like?" Chris McGratty, an analyst at Keefe, Bruyette & Woods, said in an interview. "Investors are going to focus on the bridge from the implied fourth-quarter to what next year could look like."