US banks set to boost lending income as Fed hikes rates

America’s biggest banks are set to post windfall profits on loans, benefiting from the Federal Reserve’s interest rate hikes even as they brace for a possible recession.

In second-quarter results starting this week, analysts expect JPMorgan Chase, Bank of America and Citigroup to see growth in net interest income – the difference between what banks pay on deposits and what they earn on loans and other assets.

“Main Street banking has been under incredible pressure over the past decade, due to zero interest rates for most of that time. So now it’s finally back to a more normal interest rate environment compared to the last decade,” said Wells Fargo banking analyst Mike Mayo.

Banks tend to take advantage of rising rates because they are able to increase loan fees faster than they increase deposit repayments. Mayo predicts the growth rate of net interest income from 2022 to 2024 will be the highest since the 1980s as the Fed continues to raise rates this year to fight inflation.

Loan demand is also on the rise, particularly for commercial and industrial loans and credit card loans, according to Fed data.

JPMorgan will be the first bank to report earnings on July 14, followed by Citi the next day and then BofA on July 18. Morgan Stanley and Goldman Sachs, which are geared more towards investment banking and trading, will report their earnings on July 14 and 18. , respectively.

As banks benefit from higher rates, the speed at which the Fed is raising rates is fueling fears of a US recession in the next 18 months.

Bank stocks are usually among the hardest hit during downturns and analysts expect lenders to react to the darkening economic outlook by setting aside more capital to prepare for the risk of worse lending. .

“The real question then becomes, how aggressively are they hoarding in anticipation of an economic downturn or possible recession in the next 12 to 18 months?” said Gerard Cassidy, research analyst at RBC.

Bar chart of RBC's estimates for Q2 loan loss provisions in billions of dollars showing banks made provisions for loan losses in Q2

So far, banks have said borrower credit quality has been strong, with many businesses and retail customers still sitting on funds from stimulus packages during the pandemic. Investors are watching for signs that this could change.

“It’s good to see a good quarter of loan growth and good metrics, but the focus is likely to be more, how long can this persist if we’re actually heading into a recession?” said Jeff Harte, research analyst at Piper Sandler.

More proactive loan loss provisioning is a feature of the new accounting known as “current expected credit losses” or “CECL”, which came into effect in 2020.

“This is a quarter where banks have either set up or closed with respect to problem loan loss reserves,” Mayo said.

The growing recession risk comes amid a slowdown in investment banking activity, particularly in equity capital markets, following deals such as IPOs.

On average, JPMorgan, BofA, Citi, Goldman and Morgan Stanley are expected to experience nearly 40% annual declines in investment banking fees, according to estimates compiled by Bloomberg. Analysts predict that the aggregate revenues of these banks will fall by an average of around 4.6%.

Trading revenue from volatile financial markets should offset some of this slowdown.

“You should see fairly strong trading activity offset by weak banking activity,” said Christian Bolu, banking analyst at Autonomous Research.

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