Investors have questions about how a new cycle of interest rate cuts from the Federal Reserve will affect the largest U.S. banks, and they will be looking for answers when third-quarter earnings season begins on Friday.

First up are results from JPMorgan Chase (JPM) and Wells Fargo (WFC), followed by Bank of America (BAC) and Citigroup (C) next week.

Analysts expect all four of these major banks to report their net profits fell compared to the previous quarter and the same period a year ago, as elevated interest rates in place throughout most of the third quarter squeezed lending margins.

But with the Fed cutting its benchmark interest rate by half a percentage point on Sept. 18 and more cuts expected this year and next, the bigger question for many investors is what will happen to future margins as borrowing costs begin to fall .

The largest institutions are already cutting fees for new borrowers, cutting off a key source of interest income that boosted profits in 2022 and 2023 when the Fed raised interest rates.

Read more: What the Fed’s interest rate cut means for bank accounts, CDs, loans and credit cards

But there’s also a good chance they won’t have to pay as much to retain their customer deposits, which could reduce their costs and increase their margins over time.

How this will all play out is still uncertain, and investors will be watching for any changes to the future outlook due to the Fed’s new interest rate path.

“I sense a little bit of concern about the full-year trends and how banks will cope with a rapid move in interest rates,” Scott Siefers, managing director and equity analyst at Piper Sandler, told Yahoo Finance.

“Overearning”

The key metric to watch will be net interest income, which measures the difference between what banks earn on their assets and what they pay on deposits. And as always, JPMorgan, the industry’s largest bank, will be in the spotlight.

JPMorgan made record profits in 2023 as the Fed raised interest rates to cool inflation, and its shares have risen more than 24% so far this year, outperforming most of its peers.

However, there have been signs in recent quarters that net interest income is coming under renewed pressure due to rising deposit costs. And executives have sought to adjust Wall Street’s expectations by warning that the bank “earned too much.”

Just last month, JPMorgan COO Daniel Pinto warned investors that analysts’ consensus view that the bank would generate $91.5 billion in net interest income in 2025 was “not very reasonable,” partly due to the timing and impact of falling interest rates.

The story continues

“Net interest income expectations are a little too high,” Pinto said during a speech at a Barclays conference.

JPMorgan shares fell the most intraday since 2020 following Pinto’s comments.

Some analysts are adjusting their views on JPMorgan as interest rates fall. Last week, Morgan Stanley analysts downgraded JPMorgan from Overweight to Equal Weight, saying the New York lender was expected to benefit the least from falling interest rates next year.

“We see fewer upside surprises for JPMorgan after its strong performance over the past two years,” Morgan Stanley’s Betsy Graseck wrote in a note.

Because JPMorgan shares performed so well when the Fed tightened monetary policy, it has less room for upside compared to its peers now that the Fed is easing monetary policy, she added.

A vulnerability for JPMorgan and other major banks is that variable-rate loans, which earned more interest when interest rates rose, are now valued lower.

Another reason is that the same giants didn’t have to raise their deposit rates as much as regional banks during the Fed’s tightening cycle and so will now benefit less immediately from cheaper financing, according to David Fanger, senior vice president of Moody’s Ratings.

“We expect the cost of deposits to be slower to revalue than floating rate assets,” Fanger told Yahoo Finance. “However, we expect deposit prices to catch up over time.”

It’s a challenge for any bank to quickly reduce certain deposit costs at the start of a Fed rate-cutting cycle.

That’s especially true for longer-term CDs and higher-yield savings accounts offered at so-called “exceptional prices,” said Korrynn Baltzersen, head of wealth at deposit advisory firm Curinos.

However, there are signs that some interest rates are starting to fall.

Of the 500 U.S. banks that Curinos tracks, 78% of institutions whose CD rates were above 4% have cut their interest rates since the Fed cut rates on September 18th.

According to Curinos, 50% of lenders whose savings and money market deposit accounts had an interest rate above 4% have also reduced their interest rates.

Read more: 5 CDs that pay 5% APY or more (updated weekly)

“These high prices have somehow worn out their welcome.”

The lenders that stand to benefit most from a decline in these deposit rates are the smaller regional banks, whose funding costs skyrocketed following the collapse of Silicon Valley Bank and several other large institutions in 2023.

These lenders will see a slight reversion to the mean as interest rates fall, said Chris McGratty, head of U.S. banking research at KBW.

Based on analysis by KBW, revenue growth at large regional lenders is expected to catch up with larger lenders next year, while small and medium-sized banks are also expected to see a boost.

“Rate cuts are more likely to have a positive impact on mid-sized banks,” Morgan Stanley’s Grasek said in a note last week.

Keycorp (KEY) and PNC (PNC) are among the banks that stand to benefit the most, according to Morgan Stanley analysis.

But many investors are still willing to bet that lower interest rates could ultimately be a great thing for the entire banking industry, especially if the U.S. economy avoids a recession and lenders can avoid big losses on bad loans.

Easing monetary policy could lead to more business deals, helping banks make large investment banking deals while boosting demand from consumers and businesses for new loans.

“We see a rate scenario here that will be beneficial for both the banks and the market,” Stephen Biggar, director of Argus Research, told Yahoo Finance.

“These high prices have kind of worn out their welcome.”

David Hollerith is a senior reporter at Yahoo Finance, covering banking, crypto and other financial areas.

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