Bank stocks stall amid new threat to profitability

THATSAPHON/pookpiik - stock.adobe.com

Bank investors moved to the sidelines this week, discouraged by lenders' warnings about the downside of falling interest rates.

The KBW Nasdaq Bank Index closed Thursday at 108.82, down slightly on the day and off more than 3% over the past five days. It ticked up a percentage point Friday morning but held in a narrow range.

Selling emerged after big banks reported fresh headwinds. Financial stocks fell broadly because large banks often prove bellwethers for small institutions, particularly as it relates to bread-and-butter lending.

During the week, JPMorgan Chase tempered its earnings outlook, saying it expected Federal Reserve interest rate cuts, while a potential positive for banks long term, could result in its loans repricing lower faster than its deposits. This could hamper the $4 trillion-asset JPMorgan's net interest margin and profitability, the New York company's president, Daniel Pinto, said at a Barclays conference.

"Clearly, as rates go lower, you have less pressure on repricing of deposits," Pinto said.

At the same conference, Ally Financial shared similar worries.

Chief Financial Officer Russell Hutchinson said the $193 billion-asset company holds about $60 billion of floating-rate assets that will immediately reprice lower when interest rates decline. It will take time, he said, for deposit costs to catch up.

This comes atop lingering concerns about a slowing economy and the potential for increased credit losses.

"There are always winners and losers when there is a change in interest rates," Steve Foerster, a professor of finance at Ivey Business School, said in an email. In the near term, "lower rates favor borrowers and hurt lenders. … It's really a case of two sides of the same coin." Yet, he added, it is "more nuanced" over time.

Neil Stevens, president and CEO of the $600 million-asset Oconee Financial in Watkinsville, Georgia, agreed. He said as rates decline and banks attract new deposits, they will gradually pay less for funding and margin pressure will ease. At the same time, lower rates are likely to boost credit demand, and increased volume could help banks to offset the effects of lower rates on lending.

"So yes, there are issues for us to sort through as rates fall, but it's a matter of finding the balance," Stevens said in an interview. "We are always dealing with these changes. It's a challenge, but I don't think it's a big picture problem."

To be sure, there is no panic in the market. Bank stocks are up about 12% year to date.

Stevens added that, should the Fed lower rates in small increments over several months, banks can adjust methodically.

Andrew Husby, senior U.S. economist at BNP Paribas, said that is the most likely case based on current conditions.

He expects policymakers to "refrain from a larger 50 basis point cut to start the process. Our base case is for 25 basis point cuts at each of the year's last three policy meetings, conditional on the job market not showing clearer signs of deterioration," Husby said in an e-mail.

The Fed meets next week and is expected to announce a rate reduction on Wednesday. The central bank lifted rates at the fastest pace in four decades between March 2022 and July 2023, to a range of 5.25% and 5.5%. It has kept its target rate at that level to tame inflation that soared amid pandemic-induced supply-chain snarls, government stimulus programs and Russia's invasion of Ukraine. Elevated rates drove up deposit costs for banks and, at the same time, slowed loan demand.

Mark Valentino, head of business banking at the $220 billion-asset Citizens Financial Group in Providence, Rhode Island, said steadily but modestly lower borrowing costs should prove favorable for lenders, including community banks because they cater to small businesses.

"Anything the Fed says about the pace of reductions is probably more important than the first cut itself," Valentino said in an interview. "If the Fed shows a path over the next 12 months or so of decreases, that's a positive indicator for small businesses." In addition to making existing adjustable-rate loans more affordable, "small businesses can begin to make informed capital plans for the year ahead. There's a lot of pent-up loan demand out there" that, if unleashed, could bolster banks' earnings.

Inflation eased to a three-year low in August, the Bureau of Labor Statistics reported. After topping 9% in 2022, the federal consumer price index rose at a 2.5% annual pace last month. That was within striking distance of the Fed's 2% target.

Fed officials have said over the past couple weeks that they are poised to shift their attention away from inflation and toward supporting job growth and economic expansion.

The Labor Department said U.S. employers added 142,000 jobs in August and the unemployment rate dipped to 4.2% from 4.3% in July. But the government also made downward revisions to its June and July reports by a total of 86,000 jobs, and the pace of job gains slowed from a prior 12-month average above 200,000.

U.S. gross domestic product, the broadest measure of economic activity, advanced at an annual growth rate of 3% in the second quarter, according to the Bureau of Economic Analysis. However, the Atlanta Fed's updated estimate as of Friday pegged third-quarter growth slowing to 2.5%.