Banks Poised for Strong Third Quarter, But Yellow Flags on Consumer Health Loom
Wall Street's major banks are gearing up to announce what's expected to be a robust third quarter, fueled by resilient net interest income and a surprising uptick in trading and investment banking activity. Yet, beneath this veneer of near-term strength, a confluence of unsettling trends—including a potential government shutdown and a noticeable deterioration in consumer credit health—casts a long shadow over the industry's outlook for the close of the year and beyond.
Analysts widely anticipate that the nation's largest lenders will report solid Q3 results, driven by the sustained benefit of higher interest rates boosting Net Interest Income (NII) and a modest recovery in capital markets. Investment banking, which had been in the doldrums, saw a late-quarter acceleration in dealmaking, while trading desks, particularly in fixed income, currency, and commodities (FICC), likely capitalized on market volatility. Many project a 5-8% year-over-year increase in NII for the sector, alongside surprisingly strong performance from their trading arms.
However, the celebratory mood could be short-lived. A looming government shutdown, a recurring specter in Washington, is arguably the most immediate threat. Such an event wouldn't just rattle market confidence; it could directly impede bank operations by delaying loan approvals from government-backed agencies like the Small Business Administration (SBA) and the Federal Housing Administration (FHA). Beyond the operational friction, a shutdown injects profound uncertainty into the broader economy, potentially chilling consumer spending and business investment—exactly what banks don't want to see as the holiday season approaches.
"While Q3 looks pretty good on paper, the underlying currents are concerning," notes Dr. Eleanor Vance, a senior banking analyst at Market Insights Group. "We're seeing a bifurcation: the large corporate and institutional arms are doing well, but the retail consumer is increasingly strained. A shutdown would exacerbate that strain significantly."
The most persistent "yellow flags" are emerging from the consumer loan portfolios. The long-anticipated restart of student loan payments in October has begun to bite. After a multi-year pause, millions of Americans are now facing an additional monthly financial obligation, and the initial data is troubling. Delinquency rates for student loans are already showing an upward trend, with some early reports indicating a 50 basis point jump in the first few weeks alone. This isn't just a problem for student loan servicers; it reduces discretionary income, potentially leading to increased delinquencies across other credit products held by those borrowers, from credit cards to mortgages.
What's more, the auto loan market, which had been a consistent area of growth, is also flashing warning signs. Driven by soaring vehicle prices, higher interest rates, and extended loan terms, many consumers are finding their auto payments increasingly unmanageable. Industry watchdogs have observed a steady climb in auto loan delinquencies, particularly among subprime borrowers, with the percentage of loans 90+ days past due nearing levels last seen during the 2008 financial crisis in some segments. Banks, having tightened lending standards for auto loans over the past year, are now bracing for potential charge-offs.
Banks have been proactively shoring up their loan loss provisions in anticipation of a less benign credit environment. This quarter's earnings reports will likely provide more granular detail on how much capital they're setting aside to cover potential defaults. While a prudent measure, increased provisions can eat into profitability, even as NII remains strong.
Ultimately, while the third quarter promises to showcase the resilience and adaptability of the banking sector, the road ahead is clearly fraught with challenges. The combination of a politically induced economic disruption and a deteriorating consumer credit landscape suggests that banks might be entering a period where robust revenue growth takes a backseat to vigilant risk management and a careful assessment of their loan books. Investors and analysts will be scrutinizing forward-looking statements and management commentary for clues on how these financial giants plan to navigate the increasingly choppy waters of late 2023 and early 2024.
