July 25, 2023/Fitch Ratings
U.S. large and regional bank results for 2Q23 have been broadly weaker on a sequential-quarter and year-over-year basis, largely in line with expectations, Fitch Ratings says. The weaker results reflect rising deposit costs, an uptick in provisions and continued inflationary pressure on non-interest expenses. Based on the forward curve for rates, and broad consensus of a moderate economic slowdown, bank performance should continue at similar levels through the remainder of the year, as further rises in funding and credit costs are offset by modest recovery in fee income and better controlled costs.
Banks’ net interest margin compression will likely slow in the second half of 2023, assuming that the hiking cycle has reached near terminal levels. Even as banks have revised up their estimated cumulative deposit betas, they noted a slowdown in deposit migration to higher-yielding accounts, as well as stabilization in deposit outflows. YoY deposit growth varied significantly across institutions, with higher-paying, consumer-focused banks drawing in deposits at high double-digit rates, whereas most banks saw low to high-single digit deposit contraction.
Net interest income trajectories will also depend on loan growth trends. As of 2Q23, YoY loan growth averaged in the high single-digits, favoring credit card portfolios as payment rates continued to normalize. Growth in other consumer and commercial loans was significantly more muted.
Non-interest revenue was also mixed as lower deposit and overdraft fees, plus continued weakness in investment banking and trading were balanced by higher card fees. Banks noted some signs of green shoots in markets activity, as resolution of the U.S. debt ceiling impasse and relative stability following the March banking crisis has helped revive investor appetite.
Expense growth remained elevated across most institutions but appeared to be slowing, with expectations for further moderation in 2H23. The vast majority of banks reported YoY expense growth, with a large cohort reporting high single digit or double-digit growth. Positively, however, roughly half of banks reported lower QoQ expenses. Severance charges and reduced headcount across a number of banks suggest that expense growth and efficiency ratios will likely stabilize over the coming quarters.
Banks’ asset quality continues to benefit from resilient borrower profiles. However, we anticipate net charge-offs rates to overtake pre-pandemic levels by year-end 2023, driven by credit card portfolios. Similarly, nonaccruals continued to step up on a YoY and QoQ basis, and have largely converged with long-term averages.
Credit cost growth will likely stabilize for the duration of the year, absent a larger-than-expected deterioration in credit quality, given the front-loaded nature of reserve builds against an uncertain outlook, as well as the relatively high reserve coverage of office commercial real estate (CRE) to date. Provisions stepped up meaningfully YoY, reflecting the uncertain macroeconomic outlook as well as stress in CRE, particularly office. The banks most impacted by provisions were those with large credit card books and outsize exposure to CRE.
Banks generally reported higher reserves and flat or incrementally higher capital ratios QoQ, with a cautious outlook for deployment given the uncertain economic environment coupled with a Federal Reserve’s (Fed) holistic review of capital standards, signalling higher capital standards over the medium term. The recently released Fed Supervisory Stress Tests results were largely as expected and neutral to ratings, with capital levels remaining well above required minimums.
