Net interest income, or NII, has become one of the most watched metrics on the balance sheet this bank earnings season. Banks have adjusted their guidance on it, analysts are grilling CFOs in earnings calls over their expectations for the remainder of 2024, and regional and big bank stocks alike are rising and falling on any revelations related to it.
So, what is NII? And why is it the focus of speculation, intrigue, and even concern?
Net interest income is the difference between how much interest banks earn on loans and investments, and how much they pay out to depositors. Basically, it’s the key way banks make money. When a bank is making more from the interest on loans than it’s paying out to its depositors, it has a positive NII. If the opposite is true, that bank is technically insolvent (it can keep operating, however, as long as customers don’t rush to take out their deposits at once).
Over the last few quarters, banks have welcomed a sizable windfall from NII, with most banks that have already reported earnings beating Wall Street expectations to kick off 2024. Bank of America, for example, saw $14.2 billion in NII in the three month period ended March 31 — exceeding its own guidance and topping its fourth-quarter NII by $100 million. JPMorgan Chase posted a $23.2 billion NII in the first quarter, an 11% year-over-year increase.
But nothing lasts forever. These margins are at risk of becoming compressed by both falling proceeds from assets and the rising cost of funding amid the “higher for longer” interest rate environment, said Tomasz Piskorski, a finance professor at Columbia Business School.
Bank of America CFO Alastair Borthwick said the bank expects the second quarter to be “a low point for NII” — although it’s projecting growth in the latter half of 2024, if the Federal Reserve cuts interest rates as investors are hoping.
Read more: Bank of America, Morgan Stanley and Goldman Sachs reported earnings. Here are the highlights
JPMorgan similarly issued NII guidance that implied a halving of its markets NII, from $2 billion to $1 billion. While JPMorgan CFO Jeremy Barnum said these changes are “generally revenue-neutral,” JPMorgan stock took a tumble last week as a result of the change in guidance.
And Citigroup, whose outlook already included the projection that NII excluding markets will be “down modestly” for 2024, booked a $317 million decrease in NII during the first quarter.
“I don’t expect to see year-over-year growth on the NII line anywhere close to what we’ve seen in prior quarters, just in light of how the rate environments evolved, and in light of quantitative tightening and the impact on deposit levels,” Citi CFO Mark Mason said in a call with analysts last week.
Wells Fargo also reaffirmed its guidance that NII is expected to be roughly 7%-9% lower through this year than its 2023 level of $52.4 billion.
Interest rates that stay higher for longer create storm clouds
Bank executives and analysts are becoming increasingly worried about the possibility that the Federal Reserve won’t cut interest rates as early — or as many times — this year as they had originally anticipated. And this is putting downward pressure on NII, and banks’ outlook for the year.
The central bank began its quantitative tightening campaign in March 2022, raising interest rates to between 5.25% and 5.5% in an attempt to wrangle inflation to its 2% target. The Fed has kept rates steady at this 23-year-high for the last few months as it weighs potential cuts. But the central bank has continued to dial back expectations after the consumer price index popped back up to 3.5% annually in March.
Fed Chair Jerome Powell, who had already expressed his reluctance to rush into cutting interest rates, said Tuesday that the “recent data have clearly not given us greater confidence and instead indicate that it is likely to take longer than expected to achieve that confidence.”
The Federal Open Market Committee is now widely expected to begin lowering rates in September at the earliest, according to the CME FedWatch Tool. And the 10-year treasury yield, a gauge for mortgage rates and other loans, is hovering around 4.6%.
Regional banking fears
“Everybody was hoping that interest rates would go down, and if interest rates go down then that would re-inflate the bank assets and significantly shrink the banks’ risk of insolvency,” said Piskorski, the Columbia professor. “However, interest rates are not going down, and you can see what happens to regional banking stocks: They’ve been falling.”
Memories of last year’s regional banking crisis, which led to the collapses of Silicon Valley Bank, Signature Bank, and First Republic (which was scooped up by JPMorgan in May), are still fresh. And if NII goes into the red, and customers begin to withdraw their deposits en masse (see: a bank run), that could create a worst-case scenario akin to the 2008 financial crisis.
Read more: JPMorgan, Citi, and Wells Fargo kicked off bank earnings. Here are the highlights
Regional banks — like New York Community Bancorp, which had a tumultuous end to 2023 — are likely to take the biggest hits to NII if rates stay higher for an extended period of time, said Theresa Paiz-Fredel, a senior director at Fitch Ratings. Some smaller institutions could face declines as a result of higher funding costs or changes in deposit mix and pricing, she said.
Laurent Birade, banking industry practice lead at Moody’s, said that net interest margins at regionals are likely to show signs of stabilizing this year (coming off of a red-hot 2023), which could signal to some financial institutions that it’s time to resume capital-building strategies in key areas.
“We expect the fierce competition for deposits to ease, hinting at an impending peak in funding costs for most regional banks,” Birade said. “This could mark a turning point in the banking industry’s recovery journey.”