Headwinds and Higher for Even Longer

Now that it seems “higher for longer” will be sticking around for, well, longer, recent bank earnings reports show just what kind of an effect sustained high interest rates can have on profitability. While major banks posted better-than-expected profits and revenues, they cautioned investors about the challenges posed by the current rate environment. 

Key themes include: 

The Impact of High Interest Rates: Big banks are feeling the pressure. Higher-for-longer is squeezing their core lending incomes and margins. The expectation of elevated rates for the foreseeable future, and the very real possibility banks will have to spend more to keep depositors from fleeing, are dampening their outlook for profitability. For the first time in years, net interest income is trending downward at major banks. 

Lagging Loan Performance: Despite a strong economy, there are signs of strain in loan performance, and higher credit card balances are leading to increased net charge-offs. Meanwhile, the high interest rates that are holding down home sales continue to hurt mortgage originations: They were down significantly in the first quarter compared to pre-pandemic levels. 

The Outlook for Regional and Community Banks: While the size and breadth of big banks help them navigate challenges, smaller regional and community banks—which are highly dependent on reliable net interest income—might be getting hit even harder by interest-rate risk. We’ll find out more as their reports roll in.   

Investment Banking Resilience: Investment banking divisions at the major banks propped up their first-quarter performances. Bigger fees were driven by increased activity in the debt markets and a flurry of mergers and acquisitions. But higher interest rates could eventually soften results for these operations, too, analysts warn.   

Overall, while the economy continues to show strength—“unfazed” by inflation, spendy Americans continue to rev up retail sales—prolonged high interest rates challenge banks, impacting their lending incomes and profitability outlook. 

“It’s going to be a year of headwinds—of continued headwinds,” said Mark Narron, senior director at Fitch Ratings.