Market turmoil aside, 'talk of doom and gloom overstated' for banks

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A global equity market rout, spurred by U.S. recession fears, wiped away much of the recent recovery in bank stocks. It left industry insiders and observers wrestling with questions about the economic outlook, the direction of interest rates and expectations for growth in coming quarters.

The KBW Nasdaq Bank Index had gained nearly 20% year-to-date through July. It gave back more than half of that amid the market correction that spanned Aug. 2 into the following week.

Yet bankers say the economy — and the lending landscape — remain where they stood before the stock slump. Gross domestic product continues to advance, and employers are adding jobs at a steady clip, albeit at slower paces than recent highs. The Commerce Department reported GDP grew at a 2.8% rate in the second quarter, down from the 2023 peak near 5%. The Labor Department reported that U.S. employers added 114,000 jobs in July, off from the 215,000 average of the prior 12 months but still what analysts called solid growth.

The bank index gained back more than 1% Tuesday but ticked slightly lower the next day. It was up 7.5% on the year through Wednesday, and it was up another 2% intraday Thursday.

John Buran, president and CEO of Flushing Financial in Uniondale, N.Y., said the lighter pace of GDP growth reflected the Federal Reserve's aggressive interest rate hikes over the past two years to curb inflation that topped 9% in 2022. Those high borrowing costs have repeatedly raised market fears of a pending downturn — as they did over the past week — but Buran said his $9 billion-asset bank's commercial customers "are cautiously optimistic" about their own growth prospects. Their balance sheets are "very, very stable," he said. Many continue to hire.

Similar sentiment prevailed during banks' second-quarter earnings season. 

Buran said his bank's New York City footprint is resilient. "What we are seeing here is still a robust economy," he said in an interview.

He noted that the Fed's rate strategy proved effective in that it reduced inflation to 3% by mid-2024. That put the rate of consumer-spending increases within striking distance of the Fed's 2% target without spurring a recession.

To be sure, the higher rates ratcheted up deposit costs for banks, crimping net interest margins and slowing loan demand as well. Flushing Financial's margin contracted through the first half of the year, while its loan portfolio was flat. But Buran said borrowers had begun to adjust to higher rates and started making plans for new investments. The bank's loan pipeline is healthy, he said.

"Borrowers are starting to come off the sidelines," Buran said. If the Fed begins to cut interest rates in September to support its dual mandate of moderating inflation while maintaining a strong job market, it could further hasten lending activity while lowering banks' deposit costs, he said.

"There's a sense there is pent-up demand," Buran said. He anticipates margin stability in the second half of this year and expansion in 2025.

The median second-quarter net interest margin among banks with $10 billion of assets or less fell 15 basis points from a year earlier to 3.12%, according to S&P Global Market Intelligence.

Larger banks also struggled to expand their margins. Tulsa, Okla.-based BOK Financial President and CEO Stacy Kymes said his bank's second-quarter margin clocked in at 2.56%, down five basis points from the prior quarter due to lingering higher deposit costs.

But he said the $50 billion-asset company generated loan growth of nearly 2% from the previous quarter, fueled by commercial and industrial activity, and he anticipates full-year loan growth of 5% to 7%. The interest income generated on increased volumes should support the bank's margin in the second half of the year, Kymes said in an interview.

He said the economy across the bank's footprint — which includes operations in Phoenix, Denver, Kansas City, Dallas and San Antonio — is vibrant and business owners are upbeat about their prospects for the foreseeable future. This bodes well for continued strong credit quality, he said, and overall profitability.

"Everybody is looking for a boogeyman, with a focus on commercial real estate," Kymes said. "But I think the market has overstated the risks."

Sporadic "talk of doom and gloom is largely overstated," he added.

Kymes said recent market speculation of an emergency Fed interest rate cut or a steeper-than-signaled half-point reduction in September is likely an overreaction as well. He anticipated a quarter-point cut in September, followed by another in December, in line with market expectations just a week ago.

Methodical rate reductions would signal the Fed sees a slowing but still solid economy, Kymes said. That noted, he emphasized the recent stock market gyrations merit attention because they do suggest investor concern that the slower pace of hiring in July may mark the beginning of a trend. Fewer available jobs can curb spending and, by extension, economic activity.

The presidential election season kicking into high gear could also heighten uncertainty. He cautioned the third quarter could be a wildcard of sorts on the growth front as businesses await the outcomes of the election and Fed rate meetings.

Overall, however, Kymes sees no indication of economic tumult. "I think the banking industry and economy are much more resilient than the market has given credit," he said.

Morningstar DBRS analyst Michael Driscoll echoed that thinking. He said that, even in a worst-case economic scenario, the banking industry is braced to weather a downturn.

"Despite the sharp declines" for equities, "we still view banks in the U.S. and other major markets as being resilient, having sufficient capital and liquidity buffers even if the stock market continues to decline or the U.S. falls into a recession," he said.

Moody's banking analyst Laurent Birade agreed but urged caution.

While a Fed rate cut in September "may provide some relief to bank margins, the sector must remain vigilant," Birade said. A slowdown "could stress funding markets, making it imperative for banks to enhance their credit resilience and early warning systems to navigate potential economic deceleration."