A slower economy, softening loan demand and rising deposit costs — all linked to a surge in interest rates — could weigh on community banks' net interest margins and second-quarter profits.
To protect their bottom lines, more lenders are expected to announce during earnings calls in July new cost-cutting efforts or dive into detail about expense-reduction plans already under way.
First Foundation in Dallas, which has faced
President and CEO Scott Kavanaugh said it was a "difficult but proactive decision" brought on by rapidly shifting market conditions. The industry was already under pressure from the surge in interest rates over the past year; then a spate of regional bank failures followed in the spring and amplified deposit competition and funding cost pressures.
Additionally, Kavanaugh told analysts after the company last reported earnings, "I along with our entire executive management team, in support of our aggressive expense management efforts, have elected to forego any cash bonus for the fiscal year 2023. This will reduce about $3 million in annualized executive compensation expenses."
Several other banks disclosed smaller expense reductions in recent months — or were less specific — and investors anticipate both more announcements and more detail during the upcoming earnings season.
"You definitely see the need to lower costs," Mike Matousek, head trader at U.S. Global Investors, said in an interview. "I'm sure you will see and hear a lot more about cuts and new efficiencies."
At issue: Runs on deposits contributed to the failures of Silicon Valley Bank and
Analysts at D.A. Davidson, for example, expect banks in their coverage universe to collectively report 2023 earnings that are 6.4% lower than last year. They cited in a report high costs and contracting margins due, in part, to fallout from the failures and "increasingly fierce deposit pricing competition."
Piper Sandler analysts said this week they are now looking for bank earnings this year to drop 8% from 2022. In addition to lofty costs and falling NIMs, they also cited the likelihood of a lending slowdown alongside expected weaker economic activity this year. This could diminish interest income, cut into profits and necessitate offsetting cost reductions.
"Loan growth held in surprisingly well" in the first quarter, "but it seems logical to presume it will slow along with the economy and tighter lending standards," the Piper analysts said in a report.
The Federal Reserve has boosted interest rates 10 times over the past year to counter surging inflation in the wake of the pandemic. The aggressive action has begun to work — inflation in May was half the level of 2022's peak — but it is a gradual process. Consumer prices last month were still twice as high as the Fed's preferred 2% inflation rate.
Historically, the intersection of rising rates and festering inflation tipped the economy into recession and drove up loan losses. Many banks are pulling back on lending to avoid that possibility this time around. When interest income on loans declines, banks often search for commensurate cost reductions.
A case in point: OceanFirst Financial in Red Bank, New Jersey, disclosed in an investor presentation this month that, starting in the fourth quarter, it expects operating expenses to decline by 5% to 10%. The $13.6 billion-asset company said more details would be forthcoming.
"So we see our absolute level of expenses decreasing by the fourth quarter and into next year," OceanFirst Chairman and CEO Christopher Maher said in a May interview. "You have to make adjustments to the changed environment," he added.
