The second quarter of the year was always going to be difficult for most banks. That's because the banking crisis happened in March, toward the end of the first quarter, so its full effect hasn't really been seen yet in quarterly earnings reports.
Additionally, the banking crisis seemed to wake consumers and businesses up to the fact that they could be getting more yield on their money, and deposit competition and pricing have intensified. Now, banks have begun to adjust their second-quarter and full-year forecasts.
Net interest income to decline more than expected
A major source of revenue for most banks is net interest income (NII), which is the money banks make on loans and securities after funding those assets with liabilities such as deposits. Because deposit competition and pricing have intensified and banks are pulling back on lending to preserve liquidity, this is going to hurt NII and bank margins. But it seems like many banks were caught off guard regarding just how severe conditions in Q2 would be.
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At an industry conference held by Morgan Stanley June 12-13, KeyCorp (KEY 0.62%) significantly lowered its Q2 NII projection. Initially, it had estimated NII would fall by 4% or 5% from the first quarter. Now, management thinks the decline will be more like 12%.
"Clients' deposits are staying in place, they are just more expensive, and they are going to continue to be expensive as long as rates sort of sit where they are," KeyCorp's Chief Financial Officer Clark Khayat said at the conference.
Other banks are experiencing similar issues, where deposit pricing and stickiness have been difficult to hold down, leading to a worse-than-expected outcome for NII.
Truist Financial (TFC 0.53%) CFO Mike Maguire said the bank now expects revenue to decline by 3% in the second quarter. He also lowered the bank's previous full-year revenue forecast of a 5% to 7% decline to just 3%. Citizens Financial Group (CFG 0.43%) CFO John Woods said NII is likely to be down a little more than the previous outlook for a 3% NII decline provided on its first-quarter earnings call.
On the company's first-quarter earnings call, Zions Bancorporation (ZION 1.19%) President Scott McLean projected NII to fall 7% between then and the first quarter of 2024. Now, the bank expects worse. Fifth Third Bancorp (FITB 0.22%) Chief Executive Officer Tim Spence also lowered the bank's NII outlook for Q2 from a 1% decline to a 4% to 5% fall.
Woods also said that Citizens is seeing charge-offs, which is debt unlikely to be collected and a good indicator of actual loan losses, come in a little higher in the second quarter than expected. On Citizens' first-quarter earnings call, management expected the net charge-off rate for Q2 to come in the mid-30s basis point range (35 basis points = 0.35%), but now Woods said it will likely come in around 40 basis points or a little higher.
Woods did, however, point out that some of its commercial real estate office loans, which are being watched very carefully by the entire industry right now, are maturing before peers, so it may see losses slightly ahead of its peer group.
Second-quarter results will be tough
I suspect most banks are headed for a rough second quarter because most of the effects from the banking crisis and high interest rate environment are going to be more pronounced. But I think a lot of bank valuations currently reflect this, with the SPDR S&P Regional Banking ETF down close to 25% this year. Banks like KeyCorp, Citizens, and Zions all trade around tangible book value, which is quite low for them.
Forecasts from Q2 earnings calls will be important. If bank management teams say they are starting to see further stabilization in deposits and NII starting to trough, then the stocks may find some life, but there is no guarantee that this will happen. Banks could be dealing with this kind of pressure for most of the year.
New regulatory capital requirements that are expected to come out this summer are also quite important for bank stocks because they will impact their capital return plans and also determine whether banks need to build or even raise capital. Investors should prepare for difficult Q2 results but also be looking for green shoots from management teams, because I still think many bank stocks look attractive long term.
