Understanding the Impact of High Interest Rates on Smaller Banks: An Insight into Bank Earnings
The effects of high interest rates on smaller banks are becoming increasingly evident as quarterly results are reported. Larger banks have generally performed better than their smaller counterparts, a trend that is set to continue due to the shift in expectations for Federal Reserve interest rate cuts. Analysts and investors are concerned about the impact of this shift on smaller banks, as it will squeeze their revenue while boosting revenue for big banks.
JPMorgan Chase, the largest lender in the country, is set to kick off earnings for the industry, followed by Bank of America and Goldman Sachs. The focus for all of these banks will be how the changing view on interest rates will affect funding costs and holdings of commercial real estate loans.
Smaller banks, such as Valley Bank, have been hit harder by high interest rates. Valley Bank had expected seven rate cuts this year, which would have allowed them to pay lower rates to depositors. However, if these cuts do not materialize, the bank may be forced to slash its outlook for net interest income. Smaller banks have had to pay higher rates for deposits compared to larger banks, which are perceived as safer. Rate cuts would have provided relief for smaller banks and helped commercial real estate borrowers and lenders.
On the other hand, larger banks like JPMorgan benefit from higher interest rates. They can exploit their funding advantages for longer, earning higher interest on credit card loans and investments made during a time of elevated rates. JPMorgan could potentially raise its guidance for net interest income by billions of dollars. Additionally, larger banks have more diverse revenue streams from areas like wealth management and investment banking, which will provide boosts to first-quarter results.
Another advantage that big banks have over smaller ones is lower exposure to commercial real estate and higher levels of provisions for loan losses due to stricter regulations. This difference could be critical in this earnings season. Smaller banks, like New York Community Bank (NYCB), have faced challenges in the commercial real estate sector. NYCB had to disclose significantly larger loan provisions and seek a lifeline to steady the firm. There is a record $929 billion in commercial real estate loans coming due this year, with one-third of the loans exceeding the underlying property values. If interest rates remain high, concerns over commercial real estate could negatively impact bank earnings.
The impact of high interest rates on smaller banks cannot be underestimated. Smaller banks face more deposit pricing pressure and have higher exposure to commercial real estate, making them more vulnerable to market fluctuations. As earnings season unfolds, it will be interesting to see how these factors play out and how banks adapt to the changing interest rate environment.
