NEW YORK - U.S. regional banks have a tougher road to growing profits in 2024 as they face pressure to pay more to depositors versus larger peers while demand from borrowers stays subdued.

With the outlook for interest rates more uncertain, regional lenders' earnings will also be restrained because they are tied into securities holdings that are losing money on paper instead of making loans or investing in higher-yielding assets, said analysts.

"It's going to be harder," said Richard Ramsden, a banking analyst at Goldman Sachs. "They are going to have to pay more for deposits," and loan growth will also be "challenged."

For regional banks, especially those with $100 billion or less in assets, it will become increasingly difficult to make money as they compete with large and mid-sized institutions, which are perceived as safer and offer a broader range of services, analysts said.

Goldman Sachs predicts net interest income at six of those lenders will drop by mid-single digit percentages this year.

Traders of futures contracts that settle to the Fed's policy rate are pricing in a March start to rate cuts and an end-of-2024 policy rate about 1.4 percentage points below the current level.

Still, Fitch Ratings says it expects rates to stay elevated and put pressure on smaller lenders to pay more to keep deposits relative to larger peers.

"This will remain a challenge and a drag" on lenders' interest income and margins, said Christopher Wolfe, head of North American banks ratings at Fitch. "Banks can retain deposits, it's just that they will have to pay up to keep them."

For instance, the second-largest U.S. lender, Bank of America, pays an average 0.34% to consumer depositors, while Utah-based Zions Bancorp pays about 2.10% for deposits and interest-bearing liabilities.

At 11 regional banks with assets between $50 billion and $100 billion - including New York Community Bancorp, Zions Bancorporation and Comerica - analysts expect lower earnings per share this year versus 2023, according to estimates from LSEG.

Of those, four will have lower net interest income (NII), while others will see small gains, LSEG data shows.

The collapse of three regional lenders including Silicon Valley Bank last year prompted an exodus of deposits from smaller institutions to larger banks.

Customers opened about two million net new checking accounts at JPMorgan last year. Bank of America added 500,000 accounts and has 19 consecutive quarters of growth in new accounts, CEO Brian Moynihan told investors last month.

Meanwhile, banking giants should benefit more from net interest income if the Fed cuts rates as pressure to pay higher deposit rates eases.

Fourth-quarter U.S. bank earnings kick off on Jan 12.

CREDIT DOWNGRADES

After Silicon Valley Bank took losses on its securities portfolio in March, the company collapsed and sparked the biggest industry crisis since 2008.

U.S. banks' unrealized losses on available–for–sale and held–to–maturity securities totalled nearly $684 billion in the third quarter, according to the Federal Deposit Insurance Corp. These losses will narrow as the Fed cuts rates this year.

S&P and Moody's Investors Service cut credit ratings and revised outlooks for a slew of U.S. banks in recent months, warning that funding risks and weaker profits will likely test the sector's credit strength.

S&P downgraded credit ratings of UMB Financial Corp and Comerica Bank in August, citing deposit outflows and higher rates. It also cut KeyCorp's rating, citing constrained profits, alongside Associated Banc-Corp and Valley National Bancorp.

"The pressure that regional banks presumably faced as presented by industry observers did not materialize," UMB said about the downgrade. "Liquidity, regulatory capital levels, loan portfolio asset quality, and funding sources remain strong across the sector, particularly at UMB."

Associated Bank and Valley National Bank did not immediately respond to requests for comments.

"Despite the headwinds posed by inflation, elevated interest rates and global events, regional banks remain well-positioned to continue supporting their customers and communities," said Warren Hrung, head of research at American Bankers Association.

Comerica predicts its net interest income (NII) will weaken in the fourth quarter versus the third, but could trough in 2025 before improving, James Herzog, Comerica's finance chief, told investors in December. The company declined to comment on the S&P move.

KeyCorp expects improving net interest margin (NIM) and NII, particularly in the back half of the year, CFO Clark Khayat said in December.

Zions Bancorp projects NII will stabilize as it re-prices loans to offset higher funding costs. Its NII dropped 12% in the third quarter from a year earlier, it said in its earnings presentation.

"Smaller banks are having to increase their deposit pricing faster than larger banks," said Greg Demas, CEO of Nomis Solutions, which provides loan and deposit pricing software to banks.

Deposit betas - which track how banks pass Fed interest rates moves to depositors - stood between 15% and 19% at the largest U.S. banks, versus a low-60% range at regional and community banks at the end of the third quarter 2023, Nomis estimated.

Despite the uncertain outlook, Ohio-based lender Huntington Bank benefits from higher rates because about 60% of its loans are based on floating rates, allowing it to boost borrowing costs on auto loans or mortgages more quickly than peers.

"When rates go up, the price of our assets goes up," Huntington CEO Stephen Steinour told Reuters. He expects income from interest payments to grow this year because of higher prices on floating-rate loans.

"We are asset sensitive - not every bank is," he said.

(Reporting by Saeed Azhar; additional reporting by Niket Nishant; editing by Lananh Nguyen, Megan Davies and Nick Zieminski)