Rate cuts boost bank bulls despite mixed expectations for Q3

Markets are hoping that a rate-cutting cycle will deliver banks through near-term crosscurrents, relieving credit quality strains and allowing lenders to slash funding costs and ramp up lending over time.

Bank stocks kept up with broad market gains in the third quarter, and regional banks narrowed their underperformance for the year, as expectations for a sharp pivot by the Federal Reserve firmed and then materialized. That is despite mixed analyst expectations for the period, with consensus estimates anticipating sequential net interest margin (NIM) contraction at seven of the biggest 15 banks and sequential EPS declines at 12 of them, according to data from S&P Global Market Intelligence.

The immediate impact of rate cuts will vary depending on balance sheet positioning — whether an individual bank's liabilities reprice faster than its assets. "That said, a number of banks began to reduce deposit costs during the quarter, a trend we expect to accelerate given the" cut late during the period, analysts at Raymond James said in an Oct. 2 note.

Further, lower rates should help debt service costs for borrowers, especially in commercial real estate, and "credit trumps NIM," the analysts said. "We believe bank stocks are generally attractive and favor a mix of more aggressive risk-on banks" in addition to more defensive names.

– Set email alerts for future data dispatch articles. – Download a template to generate a bank's regulatory profile. – Download a template to compare a bank's financials to industry aggregate totals.

Near-term NII pressure

For the third quarter, analysts anticipate sequential net interest income increases at 10 of the banks despite the uneven expectations for NIMs. That includes a consensus projection for a 7.3% sequential increase in net interest income at Truist Financial Corp., and a 3.4% increase at KeyCorp.

Truist sold its insurance brokerage and KeyCorp sold a stake to Bank of Nova Scotia, and both banks used much of the capital to absorb the hit from selling low-yielding bonds.

With the Fed expected to continue to cut aggressively after its initial move of 50 basis points in September, the outlook matters more.

Analysts expect the cuts to generally dent banks' net interest income forecasts over the near term, with yields on banks' cash holdings and other variable-rate assets reacting instantaneously.

However, the deposit landscape has improved overall, and "we expect stabilizing deposit costs and easing funding pressures likely dependent on how sensitive banks' deposit books are to rate cuts," Piper Sandler analysts said in a Sept. 23 note. "Earnings and revised guidance should build up a more refined path" for net interest income and margins.

Rosy credit

Analysts do expect credit provision expenses to increase sequentially at 12 of the banks, though generally in the context of continued normalization from the exceptionally low loss rates during the pandemic.

"While we should see one-offs here or there, we expect banks to largely report relatively strong metrics and with rate relief coming to continue to paint a rather rosy picture overall," the Piper Sandler analysts said.

New York Community Bancorp Inc. is one of the banks that analysts expect to post a sequentially lower credit provision expense and is among the CRE-heavy banks where negative sentiment has eased because a sharp fall in medium-term interest rates should help stressed borrowers.

Lower rates also stand to revive loan growth from its sluggish pace in recent periods, which has crimped revenue.

"With the 5-year Treasury now around 3.5% several bank managements have indicated that deals are beginning to pencil which could result in an improved outlook for loan growth into 2025 if the environment holds," the Raymond James analysts said. "Though some managements also noted that some customers are holding out for even lower interest rates."