Spending set to continue to weigh on bank earnings

Higher spending dampened earnings growth in the fourth quarter as banks paid higher salaries and spent more on marketing and technology, a trend that is expected to continue in 2022.

While the industry benefited late last year from excellent credit quality, strong fee income and early signs of a recovery in loan demand, it has also grappled with the inflation, which has pushed up the cost of doing business.

Over time, the interest rate hikes the Federal Reserve plans to implement starting next month should help contain inflation. Another expected benefit: higher interest rates tend to increase interest income by more than the increase in prices banks pay for deposits.

Nevertheless, in the short term, banks may struggle to achieve positive operating leverage, which occurs when revenue growth exceeds expense growth.

“As rates rise you should see moderate inflation, but the question is how long and at what level,” said Christopher McGratty, managing director of Keefe, Bruyette & Woods.

He expressed hope that operating leverage will widen in 2023 as inflationary pressures ease and bank revenues rise.

At JPMorgan Chase, fourth-quarter noninterest expenses totaled $17.8 billion, up 11% from the same period a year earlier, largely due to higher employee compensation and increased spending on technology and marketing.

The largest bank in the country expects non-interest expense to rise 8% year ahead, executives said during the company’s Jan. 14 earnings call. These expenditures are expected to include a 35% increase in the bank’s marketing budget and a 20% increase in technology spending.

CEO Jamie Dimon defended the spending as necessary to compete with other banks and fintech start-ups. “It’s a lot of competition, and we intend to win,” he said.

Employee benefits and compensationwhich are typically a bank’s largest costs, have been rising at a faster rate during the pandemic than before, according to data from the Federal Deposit Insurance Corp.

Industry-wide wages and benefits reached $189 billion in the third quarter of 2021, up 6.6% from the first nine months of 2020, according to FDIC data. A year earlier, the comparable increase was 4.7% and the year before, it was 3.3%.

For BankUnited in Miami Lakes, Fla., higher compensation spending led to a 52% increase in noninterest expenses compared to the fourth quarter of 2020. Late last year, the bank assets of $36 billion paid each of its employees a special bonus of $5,000 to recognize their hard work throughout the COVID-19 pandemic and to lift their spirits during a time of widespread exhaustion.

“This is a very wise, long-term investment in our people,” Chief Executive Officer Rajinder Singh said on a Jan. 20 conference call.

M&T Bank in Buffalo, New York, reported operating expense growth of 5.6% in 2021, which CFO Darren King described as “an unusually high rate.”

The bank with assets of $155.1 billion also forecast spending growth of 3% to 5% over the coming year, anticipating an increase in compensation and employee benefits, an increase in advertising expenses and increased data processing and software costs.

M&T executives said all of these costs are tied to revenue growth. For example, data processing costs are affected by volume, and an increase in commission income will cause some increase in expenses.

“It’s hard to say what the new normal is, given the inflationary environment we find ourselves in,” King said on a Jan. 20 conference call.

At Citizens Financial Group, non-interest expenses totaled $1.06 billion in the fourth quarter, up 5% from the same period a year earlier. According to executives, this increase is due to both higher employee compensation and costs associated with acquisitions.

The Providence, Rhode Island company said it expects spending growth of about 5% to 6% in 2022, driven in part by the full impact of its recent purchase of JMP Group, a capital markets firm in San Francisco.

At Capital One Financial in McLean, Va., marketing spend rose about 33% from the prior quarter to $1 billion. The credit card issuer with $488 billion in assets said it intended to continue spending on marketing as long as that spending remained productive, citing a desire to capitalize on renewed consumer borrowing.

“When we see opportunities, we really lean into them,” said Richard Fairbank, Chairman and CEO. said in a January 25 conference call.

For bankers, the hope is that higher interest rates will help moderate inflation and the competitive labor market will cool. Ongoing consolidation within the banking industry could also offset some of the effects of wage inflation, since M&A deals often involve some cost-cutting measures, McGratty said.

He said in hindsight, industry watchers shouldn’t have been surprised by the growth in spending during the fourth quarter, given the inflationary pressures in the U.S. economy.

“We are in a period of rising margins, but how much will that be offset by wage inflation?” McGratty said.

Allissa Kline contributed to this story.

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