Big banks ready themselves for Fed rate hikes — which could be good and bad

The Federal Reserve hasn’t done anything with interest rates yet, but bank earnings released Friday show that the mere anticipation of a pullback in easy money policies is weighing on the industry.

On Friday, three of the nation’s four largest banks reported earnings covering the final quarter of 2021: JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC).

At Wells Fargo, bread-and-butter loans and strong expense management made the San Francisco-based bank the only stock winner among the largest banks in Friday’s trading session. At the other two large banks that reported, deflated fixed income, currencies, and commodities (FICC) trading led to a sour reaction from the street.

“We broke open the piñata today on earnings, the operative word is ‘in-line,’” Hennessy Funds Portfolio Manager David Ellison told Yahoo Finance Monday. “I think that’s why the stocks are trading down. There’s no surprises, there’s nothing special under the Christmas tree.”

As the Fed messages its intention to ratchet up short-term borrowing costs to quell inflation, the banking industry may be seeing a pivot away from the profitability of capital markets businesses in favor of greater net interest income in loan portfolios.

That would be a reversal of the trend seen during the early parts of the pandemic recovery, where near-zero interest rates had large banks learning on their trading desks to boost revenues.

The bad

FICC was a bright spot for the banks during the depths of the pandemic, but the good times for trading appear to be fading with Fed normalization nearing.

JPMorgan Chase saw a 16% year-over-year decline in its FICC business. Citigroup saw a 16% decrease.

During the quarter, the Fed began signaling that it could more quickly pullback its pandemic-era policies (of near-zero rates and asset purchases). Longer-dated U.S. Treasury yields surged higher on anticipation of Fed rate hikes.

Citigroup CFO Mark Mason told reporters Friday that the “challenging trading environment” was due to the Fed’s new positioning, which took steam out the company’s rates and spread products businesses as clients moved to de-risk.

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JPMorgan Chase CFO Jeremy Barnum warned future quarters could see a continued downshift in FICC revenues.

“As the monetary policy environment evolves next year, that could actually create some tailwinds for that business,” Barnum told analysts Friday morning.

The good

Although the Fed policy shift took some steam out of FICC trading, analysts say banks should benefit from higher rates too.

That’s because anything above the status quo (of near-zero interest rates) would allow banks to collect more interest revenue on loan products. At JPMorgan Chase, the company says net interest income will rise to roughly $50 billion this year — compared to just $5.5 billion last year.

“When we look at the outlook for Fed fund rate increases, if they come in higher than expected, that will benefit the banks of course,” RBC Capital Markets Bank Analyst Gerard Cassidy told Yahoo Finance Friday.

Wells Fargo would be a beneficiary of this, since consumer banking makes up a larger share of their business compared to the other three mega banks (FICC is not even a $1 billion revenue stream).

Even though a regulatory asset cap (due to the company’s fake accounts scandal) limits their loan growth, revenue jumped 12.8% year-over-year. The boost appeared to be partly the result of a 27% increase in non-interest income (like fees), but interest rate hikes could further improve the company’s performance.

A number of other large banks are scheduled to report earnings next week; Goldman Sachs (GS) results are expected on Tuesday, followed by Bank of America (BAC) and Morgan Stanley (MS) on Wednesday.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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