Banks: Q2 2023 earnings season themes

Operating environment

When banks last reported earnings, the industry was in the midst of dealing with the repercussions of the bank failures that occurred in March and the impact they had on customer behavior. Now that a few months have passed, analysts and investors will be interested in hearing about the current operating environment and if the heightened concern among customers has passed and we are seeing a return to a more normalized environment.

Deposit trends

Deposit flows and pricing continue to be the primary areas of interest for analysts and investors. The second quarter trends will be an important indicator for determining which banks have seen more stability in their deposit bases and which have continued to see outflows as customers look to move funds to stronger financial institutions or increase their insurance coverage. Some banks typically experience deposit outflows in April related to tax payments, so it will be important for management teams to indicate if outflows early in the second quarter were the usual seasonality and not reflective of customers moving money out of the bank. During the first quarter earnings season, many banks indicated they believed they would be a beneficiary of the turmoil in the banking industry and have opportunities to add new deposit relationships. To provide an indication of their success in this area, banks should consider reporting on the number and/or dollar amount of new deposit accounts opened in the second quarter.

Excess liquidity

In response to the deposit outflows experienced in the wake of the bank failures in March, many banks increased their cash balances through the use of borrowings and/or short-term brokered deposits, which contributed to the decline in net interest margin that most banks experienced in the first quarter. Analysts and investors will be interested in seeing which banks have been able to revert back to more normalized level of cash balances and which feel the need to continue carrying a higher than normal level. For those that have reverted back to a more normalized level, they should be prepared to indicate at what point during the second quarter they decreased their cash balances. And for those that continue to carry a higher than normal level, it’s helpful to provide the basis point impact on net interest margin from the excess liquidity so that analysts and investors can get a better sense of the trend in margin from changes in funding costs and asset yields.

Loan growth

Higher rates and the potential recession continue to impact both loan demand and the risk appetite that banks have for new loan production, with funding pressures and elevated loan-to-deposit ratios also creating lending constraints for many banks. As a result, it has become a difficult year for many banks to forecast loan growth. Analysts and investors will be looking for updates on levels of new loan production and trends in loan pipelines, as well as which areas of lending that banks are still focusing on, which areas where they are still seeing a meaningful amount of loan demand, and which areas where they are limiting new production. They will also be interested in the pricing on new loans and if the spread relative to incremental funding costs is accretive or dilutive to net interest margin.

Credit quality

While asset quality generally held up well during the first quarter, concern about a coming credit cycle has continued to increase, particularly around certain asset classes like office CRE. Many banks provided increased disclosures around their office CRE loans with their first quarter earnings reports, which analysts and investors found helpful in understanding the potential risk inherent in their portfolios. Until concern about office CRE decreases, banks should continue to provide these increased disclosures and update them each quarter as loans roll-off and more current financial and appraisal data is obtained. Investors and analysts will also continue to be looking for more data around early warning signs of credit deterioration, particularly trends in watchlist and substandard loans.

Expenses

In response to the more challenging operating environment, many banks announced expense reductions along with their first quarter results. With the near-term economic environment remaining highly uncertain, analysts and investors will be interested in hearing if banks are continuing to look at opportunities to reduce expenses or if banks are moving forward with planned investments in talent, technology, product introductions, and market expansion in order to capitalize on the opportunities they see to take market share and grow their client base as a result of the turmoil in the banking industry.

Capital

Capital management is always a topic of interest for analysts and investors, but it has become of even more interest in the current environment as the decline in valuations in the banking sector has made stock repurchases more attractive, while the potential for a recession has put many banks in the mode of capital preservation. Accordingly, analysts and investors will be interested in hearing from management teams about whether they feel the need to preserve or even build capital, and whether changes in the dividend payout and/or stock repurchases are being considered.

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