Banks aren't totally out of the woods yet
They've stabilized somewhat but still face pressures.
Is the operating environment as tough for banks as suggested by a handful of downgrades from the three major ratings agencies, Standard & Poor’s being the latest? In the near term, probably not. S&P itself notes that stability in the sector has improved since early spring’s disturbances, with moderating deposit declines, solid earnings and manageable exposures to riskier commercial real estate (CRE) loans. An economy that continues to exhibit surprising strength can cover a lot of warts.
But investors nonetheless should appreciate underlying concerns ratings agencies raise. Banks face multiple challenges. 525 basis points of policy rate increases since March 2022 from a Fed that may not be done. A renewed rise in long yields, which hurts the value of longer-duration Treasuries and other assets that remain on bank balance sheets. Tighter credit standards as disclosed in the latest Federal Reserve Senior Loan Officer Survey. And particularly among smaller regionals, CRE holdings battered by WFH policies that have driven vacancies up and values down.
Higher rates, loan defaults, a mismatch between lower-rate assets and higher-rate liabilities are real issues for banks, and bank profits. As long as economic growth keeps humming along, with still-low weekly jobless claims (today’s read again came in well below expectations) and a consumer willing and able to keep spending, banks should be able to address these credit issues over time, rather than in a sharp, crisis atmosphere. The longer this steady period continues, the better for bank balance sheets. This will take time, and a bit of luck. Recession forecasts are fading but haven’t disappeared. In the meantime, prudence is warranted for potential bank investors.