Five trends to watch in banks' Q4 earnings

January 11, 2024 9:00 PM

What a wild year 2023 was for banks — higher interest rates, regional bank failures, large deposit outflows, fast-rising deposit costs and, for much of the year, sinking stock prices.

The full-year picture will begin to come into view Friday when the four largest U.S. banks report their fourth-quarter earnings.

JPMorgan Chase, the largest U.S. bank, kicks off the season, along with Wells Fargo, Bank of America, Citigroup and Bank of New York Mellon. A bounty of regional banks will roll out their reports next week.

By and large, analysts say they expect a fairly stable quarter, albeit one that includes an increase in provisions to help shield against anticipated higher credit losses. Loan growth is likely to be soft, while deposits are expected to further stabilize.

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Then as 2024 progresses, the sector has a good chance of recording stronger earnings, analysts say.

"Profitability improvement should accelerate the further we get into the year," Piper Sandler analyst Scott Siefers said in a research note. "Of course, the big wildcard in all of this is whether we get the hoped-for soft landing, lack of which could derail a benign credit outlook."

Here's a look at what analysts are anticipating as earnings season swings into gear.

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Loan growth will be muted

Industry analysts believe that loan growth continued to soften in the fourth quarter amid downward pressure on both loan supply and loan demand.

Morgan Stanley analysts wrote in a note to clients that, at the banks in their coverage universe, they estimate that year-over-year loan growth slowed from 4% in the third quarter to 2% in the fourth quarter.

"On the supply side, banks continue to tighten underwriting standards," the Morgan Stanley analysts wrote, citing higher capital requirements as one reason for the more restrictive standards.

Meanwhile, loan demand continues to weaken due to higher interest rates, according to the Morgan Stanley analysts. They predicted that demand for commercial loans could continue to weaken, as companies gain greater access to the capital markets and use that access to arrange fixed-rate, longer-term financing.

Analysts at Wedbush Securities wrote that loan demand could potentially stabilize in 2024, given that market interest rates have recently dropped. But they acknowledged that loan growth likely remained weak in the fourth quarter, pointing to Federal Reserve data and recent commentary from bank executives.

One exception to the expected sluggishness in loan growth could be the credit card business.

"Loan growth remains strong," analysts at Jefferies wrote in a note about the credit card industry, "driven by robust consumer credit demand, especially during the holiday year-end period."

Outflows will ease, but deposits will still be down year over year

Deposits were perhaps the most dominant subject in banking in 2023. Even before the spring failures of Silicon Valley Bank, Signature Bank and First Republic Bank, banks were facing pressure to pay customers' higher rates to retain deposits, or risk losing those deposits to money market accounts and U.S. Treasury securities, which were offering better yields.

Three bank failures in a row, driven by massive withdrawals of deposits, led to even more outflows across the industry and substantially increased the pressure on banks to pay more to depositors.

Deposits are still in flux, but there's more stability these days. Deposits fell 0.49% in the third quarter, an improvement from the decline of 0.53% in the second quarter and the 2.46% tumble in the first quarter, analysts at S&P Global Market Intelligence noted in a report.

The Wedbush analysts wrote that they expect the fourth quarter to be the second consecutive quarter with "modest sequential deposit growth," following five straight quarters of industry-wide outflows. Deposits will still be down year-over-year, they projected, though the competition for deposits has been easing.

That's evident in certain rate cuts that banks have been rolling out. For example, over the past month, banks have begun reducing their offer rates for new certificates of deposits, according to the Morgan Stanley analysts.

Expenses will likely continue to grow, but cost-cutting remains a priority

At many banks, expenses rose in 2023, in part because they spent more on wages, technology upgrades and fraud losses. Bank of America set out to rein in expenses after they soared during the first quarter of last year. At Truist Financial, management has predicted that the bank's 2023 expenses would rise about 7% year-over-year.

Analysts are forecasting more expense growth for the fourth quarter, albeit at a moderate pace. In a research note, analysts at RBC Capital Markets wrote that, among the banks they cover, they expect median noninterest expenses to rise by 0.1% compared with the third quarter and 2.1% year-over-year, largely as a result of higher payroll and technology spending.

Analysts at Compass Point Research & Trading said that smaller banks could report even higher expense growth year-over-year — 3.4% versus 2.3% at the regional banks that the firm follows. Further, noninterest expenses "should generally rise in 2024, but at a lesser extent than 2023," as banks deal with wage inflation, technology costs and Federal Deposit Insurance Corp. assessment fees, which are expected to increase as a result of the bank failures, the Compass Point analysts wrote in a note to clients.

Several banks are currently in cost-cutting mode. Truist plans to chop out $750 million over a 12- to 18-month period, largely through job cuts, but also by spending less on technology. PNC Financial Services Group in Pittsburgh aims to save $325 million, also by reducing the size of its workforce.

Comerica in Dallas, which warned of impending expense cuts in October, confirmed those intentions Wednesday in a regulatory filing. The bank acknowledged that it has "begun certain initiatives it expects will calibrate expenses to enhance earnings power while creating capacity for strategic and risk management investments."

City National Bank, a division of Royal Bank of Canada in Toronto, is also looking to bring down costs as a way to improve profitability, RBC executives said this week. The Los Angeles-based bank reported losses of $285 million between May and October 2023.

Some analysts think there's a good chance that more banks will announce expense reductions — and that if they can't get their expenses down, they might have to think about selling themselves.

Banks in the latter category "will face earnings walls and that should ultimately prompt more M&A discussions as deals offer the opportunity to cut costs," the S&P analysts wrote.

Credit trends will keep “normalizing” as charge-offs tick upward

If there's one word that bankers love to toss around when talking about credit trends, it's "normalization." During the pandemic, credit quality across the industry was pristine, as consumers and corporations socked away excess cash and paid off debts in a timely manner.

But that cushion has started to deflate, and net charge-offs have started to rise, though analysts are very clear that the sector is far from seeing significant deterioration.

The Wedbush analysts project that net charge-offs at regional banks increased by 40 basis points in the fourth quarter, down slightly from 39 basis points in the third quarter. They are also forecasting an increase in expenses related to provisions that are set aside for potentially souring loans.

Commercial real estate loans — and office loans in particular — will be closely watched, the Wedbush analysts wrote.

On the consumer front, credit card net charge-offs and delinquencies are expected to rise in the fourth quarter, according to a note from analysts at Jefferies.

"Credit losses are still at unsustainable low levels," RBC Capital Markets analysts wrote in a report. "But they have started to normalize in the [third quarter] and we expect further normalization" in the fourth quarter.

Banks will continue to build capital in anticipation of tougher rules

Banks have been boosting their capital ratios in anticipation of Basel III endgame rules, which are expected to result in higher capital requirements. Analysts anticipate that the capital accumulation will continue in the fourth quarter.

"Buybacks are still largely on hold for a number of our larger banks under coverage due to changing industry regulations and uncertainty in the market," the Compass Point analysts wrote.

One factor that likely helped banks to build their capital ratios during the fourth quarter was lower long-term interest rates, which reduced unrealized losses on securities holding. But that tailwind may have been offset, at least partially, by the special assessment from the FDIC.

The capital accumulation efforts are expected to continue in the first half of 2024, until there is more clarity about new capital rules, the Wedbush analysts wrote.