WASHINGTON — The Federal Deposit Insurance Corp. said the banking industry remains resilient amid a string of bank failures this spring, but a difficult interest rate environment, slower growth and potential losses in commercial real estate investments mean the industry is not yet out of the woods.
FDIC Chair Martin J. Gruenberg said the banking industry's metrics showed resilience, with high net income, favorable asset quality metrics and strong capitalization. However, he noted the full impact of the industry's recent upheaval may not be evident until next quarter.
"The industry's quarterly results do not yet fully reflect the stress that began in early March," he said. "Rising market interest rates, slower economic growth and geopolitical uncertainty…[could] weaken credit quality and profitability and could result in further tightening of underwriting, slower growth and higher provision expenses."
In the first quarter, the banking industry reported net income of $79.8 billion, an increase of $11.5 billion from the previous quarter. According to Gruenberg, March's bank failures were largely responsible for that increase.
"Strong growth in noninterest income, reflecting the accounting treatment of the acquisition of two failed institutions and record high trading revenue of large banks outpaced the lower net interest income and higher noninterest expense," he said. "Industry net income would have been roughly flat quarter-over-quarter without the accounting impact of the two failed bank acquisitions."
Despite higher income, it appears consumer faith in the banking system was shaken by recent stress and may be slower to recover. Banks saw a decline in total deposits for the fourth consecutive quarter, although the agency said deposit outflows have moderated since March.
The net interest margin for the banking industry saw a modest seven basis point drop from last quarter to 3.31%, but continued to exceed the pre-pandemic average of 3.25%. Interest rate spreads varied from bank to bank, however, as community banks continued to report higher net interest margins than the overall industry.
Gruenberg said loan yields and deposit costs both increased amid rate hikes in the second and fourth quarters of last year. He said that trend reversed in the first quarter of this year because of changes in consumer behavior; banks continued to earn higher interest rates on loans, but their costs to depositors more than offset those gains.
"Yields on loans increased by 32 basis points while the cost of deposits increased by 43 basis points over the course of the quarter," Gruenberg said. "The industry reported a sizable shift from lower yielding accounts such as transaction and savings accounts into higher yielding time deposits which explains much of the increase in deposit costs."
That net-negative dynamic will likely moderate as interest rates stabilize, he said.
"Historical experience suggests that the gap between changes in loan yields and deposit costs tends to increase in rate rising cycles, but then decreases and often reverses when market rates stabilize or decline."
Gruenberg also said the Deposit Insurance Fund balance was $116.1 billion at the end of the first quarter, representing a reduction of $12.1 billion from the previous quarter. That reduction reflects losses borne because of the failures of Silicon Valley Bank, Signature Bank and First Republic Bank, but the increase in deposit insurance assessments that went into effect in January partially offset those losses.
The reserve ratio, which indicates the fund balance relative to insured deposits, decreased by 14 basis points to 1.11 percent, its lowest level since 2015. Despite the decline, the agency insisted the reserve ratio is on track to reach the statutory minimum of 1.35 percent by September 2028.
As before the March failures, Gruenberg said the banking sector continues to face challenges from elevated unrealized losses on investment securities and significant downside risks including inflation, rising market interest rates, slower economic growth and geopolitical uncertainty.
Gruenberg also put particular emphasis on the risks the commercial real estate market poses to the banking industry. He said office-backed commercial real estate loans may face challenges if demand for office space remains weak and property values continue to soften.
"There are significant numbers of banks in the United States that have significant CRE exposures," Gruenberg said. "We're particularly focused on office buildings and commercial office space in a number of large metropolitan areas, where we have the leases on buildings expiring and the holders of those properties may not be able to charge as much on the renewal of those leases, while the cost of financing the mortgages on those properties may be going up."
Chairman Gruenberg's remarks continued to emphasize the resilience of the banking industry despite recent stress. However, as he said, the industry faces significant downside risks that could impact credit quality and profitability.
"The FDIC will be focused on monitoring the condition of the banking industry, including the impacts of the recent bank failures on liquidity and taking appropriate supervisory actions."
Bank industry analysts expressed measured satisfaction, saying the first quarterly report indicated future bank failures are unlikely, and that FDIC is satisfied with their fee structures for now. Jaret Seiberg of TD Cowen is cautiously optimistic, saying the effects of the failures would not be fully understood until the Q2 quarterly banking profile is published in August.
"FDIC is unlikely to further increase deposit insurance assessments," Seiberg said in an email. "This is because the FDIC reports that the deposit insurance fund is on track to meet its statutory minimum even with the recent losses and the growth of insured deposits."
