How fewer expected rate cuts will affect bank’s outlooks – Morgan Stanley (NYSE:BAC)

U.S. banks’ earnings season is just around the corner, and with market expectations for the number of interest-rate cuts cut in half since the start of 2024, certain lenders are expected to implement material revisions to their outlook for net interest income (“NII”) to reflect the new macroeconomic environment.

A months-long standoff between market and the Federal Reserve has drawn to a close, as much of the economic data so far this year have reinforced the monetary authority’s case for caution. In January, fed funds futures traders had priced in six to seven quarter-point rate cuts by the end of 2024. Now, with inflation proving stickier than expected, traders see three reductions starting in June or July, aligning with the central bank’s median projection issued earlier this month.

“In general, fewer rate cuts are a tailwind to NII outlooks for most Large Cap Banks, and a headwind for several Midcap Banks,” Morgan Stanley analyst Manan Gosalia wrote in a recent note. That’s because, he added, big banks have higher asset yields and slight incremental deposit pricing pressure, while midcap banks have faced higher funding costs and deposit pricing pressures during the Fed’s rate-hiking cycle in 2022 and 2023.

Higher-for-longer rates generally could be a boon for banks (depending on their size), so long as they garner higher rates from borrowers while keeping deposit rates relatively low. Beyond NII, though, higher rates could lead to increased loan losses as both consumers and businesses struggle to keep up with higher borrowing costs.

Gosalia is most optimistic about the potential upside to NII – the amount of interest banks receive from assets less what they pay on their debts – for revenue outlooks on Bank of America (NYSE:BAC), State Street (NYSE:STT), and Wells Fargo (NYSE:WFC). On the other side of the fence, he sees the most downside risk for Valley National Bancorp (NASDAQ:VLY), Cadence Bank (NYSE:CADE), and Fifth Third Bancorp (NASDAQ:FITB).

Wells Fargo (WFC) already has seen NII decline Y/Y in Q4 2023, with further weakness expected this year. JPMorgan (NYSE:JPM), the U.S.’s largest bank, saw its NII climb 19.1% during the period, though 2024’s mark is expected to come in roughly flat vs. 2023.

On Bank of America (BAC), in particular, the lender “benefits from their high asset sensitivity (which helps given 3 fewer cuts in the current forward curve relative to the prior guide), high cash position, low loan to deposit ratio (“LDR”) and strong low-cost core deposit base,” said Gosalia, who stands at 2% above the Wall Street estimate for BAC’s 2024 NII. Wells Fargo (WFC) and State Street (STT) also benefit from asset sensitivity, he added.

Valley National (VLY), Cadence Bank (CADE), and Fifth Third (FITB) all have one thing in common: a high loan-to-deposit ratio, the note said, meaning they have made a large amount of loans compared with their deposits, a sign of reduced liquidity, and increased risk of running out of funds to meet customer withdrawals.

Not all banks are likely to update guidance next month, the analyst noted, as “management teams do not want to chase the forward curve throughout the year.”

Take a look at how the SA Quant system ranks U.S. diversified and regional banks.