Big banks' deposit cost pressures are a warning sign for regionals

Two of the biggest banks in the country, JPMorgan Chase and Wells Fargo , are raking in tens of billions of dollars a year in interest.

That's apparently not enough to please their shareholders, who punished JPMorgan in particular for saying it may not make too much more than that this year. The bank's stock price sank 6.47% on Friday, partly since rising deposit expenses meant its guidance on net interest income was roughly flat.

Wells Fargo shares fell slightly and closed down nearly 0.4%. Share prices at other banks also generally fell as investors await their earnings reports starting next week.

"All of the banks sold off to varying degrees, but the stocks had run up too much," bank analyst Meredith Whitney wrote in a note to clients.

The big banks' guidance, while disappointing to some, was not overly surprising. It took longer to happen than at regional banks, but megabanks aren't immune from the competition for deposits, which has forced banks to pay higher rates to their depositors.

Hopes are quickly dimming that the Federal Reserve will cut interest rates soon, thus lessening the blow that high rates are inflicting on banks. With rates poised to stay relatively high, investors are coming to the realization that the rate picture will "erode the value of future earnings" at banks, said Brian Mulberry, portfolio manager at Zacks Investment Management.

"Future earnings are going to be suffering under the weight of higher interest rates held higher for longer," he said.

Higher interest expenses don't matter much if banks are taking in more interest on loans, but banks aren't pulling on that lever much. Outside of their credit card businesses, JPMorgan Chase and Wells Fargo executives said they aren't seeing particularly strong demand for loans.

Jeremy Barnum, JPMorgan Chase's chief financial officer, said commercial customers "remain cautious." His counterpart at Wells Fargo, Michael Santomassimo, shared a similar outlook.

"They're being cautious still and saying, 'OK, I'm not going to build inventories as much as I might in a different environment,'" Santomassimo said.

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In the meantime, high rates continue to dampen mortgage lending, with few borrowers seeking to refinance. The commercial real estate market is also soft.

The double whammy of slower loan growth and higher deposit costs meant neither bank raised their forecasts for net interest income much, if at all. Wells Fargo executives stuck to a prior forecast that their net interest income will be 7% to 9% lower than last year, when the bank raked in $52.4 billion.

JPMorgan Chase, meanwhile, said it expects to see net interest income of $90 billion this year, unchanged from its earlier projection. Executives emphasized the better figure to examine is its net interest income excluding its market division, where changes to NII are "generally revenue-neutral," Barnum said. The bank upped its guidance for that figure by $1 billion to $89 billion this year.

The big banks' mostly unchanged projections on interest income points to challenges that regional banks may see as they report earnings starting next week. Regional banks started seeing their deposit costs rise sooner, and the outlook for loan growth isn't all that strong, partly since their credit card portfolios are smaller than those at big banks.

Those are among the reasons why the ratings agency Fitch says the outlook is "deteriorating" for U.S. banks this year.

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

Banks are seeing a bit of relief on consumer deposit costs, as they've been able to slightly lower the rates they pay on certificates of deposit. But the rates they're paying are still relatively high, north of 4% for some CDs.

More importantly, more consumers are realizing they can get more bang for their buck by sticking their cash in those CDs, rather than earning next to no interest in regular savings accounts.

The shift toward CDs is the "dominant trend that is driving the increase" in JPMorgan's consumer deposit costs, Barnum, the bank's CFO, told analysts. The megabank is "very happy about what that means" due to the high levels of consumer engagement, Barnum said, but the bank is still capturing those funds "at a very high rate."

"We really don't think it makes sense to assume they're in a world where checking and savings is paying effectively 0 and the policy rate is above 5%, that you're not going to see ongoing migration," Barnum said.

Barnum said he sees "some evidence that maybe it's slowing a little bit" but that he remains cautious on that. The bank expects to see "ongoing migration and yield-seeking behavior" even if the Fed cuts rates, he added.

Santomassimo, Wells Fargo's CFO, said the pace of the migration to CDs will stabilize as consumers spend down more of their cash and get to their "core operating balance." That's the typical cushion that customers keep in their bank account for their daily expenses and emergencies, rather than the extra money they might stick into a CD.

"At some point soon … we would expect that to stabilize, but we'll see exactly where it does," Santomassimo said.

Banks have also long been battling for business customers' cash, as corporate finance officers were fast to demand higher yields on their cash when the Fed began raising rates.

"As you look at the commercial side, not much has changed. It's pretty competitive," Santomassimo said, adding he does not see a shift occurring until the Fed cuts rates.

The executives also offered some caveats with their guidance, noting the rate forecasts and how customers respond aren't an exact science.

The changes at Wells Fargo have more or less been "a touch less here, a touch more there," CEO Charlie Scharf told investors, nothing that triggers a major change in guidance.

"We want to be really careful in all this, right?" Scharf said. "We're trying to be as transparent as we can be about what we're seeing without getting over our skis and making predictions that none of us have the answers to."

Jamie Dimon, the JPMorgan Chase CEO, also told analysts that their forecasts are based on market forecasts of Fed policy that "have always been wrong."

"You have to ask the question, what if other things happen? Like higher rates with this modest recession, etc., then all these numbers change," Dimon said, adding that he thinks the chances of a tougher economy are "higher than other people" predict.

"We don't want to guess the outcome," he said. "I've never seen anyone actually positively predict a big inflection point in the economy literally in my life or in history."

And he touted the bank's strong capital levels, which prompted a bump-up in its dividend payouts to shareholders.

"We're earning a lot of money," Dimon said. "Our capital cup runneth over, and that's why we increased the dividend."