The prospect of falling interest rates — which would lower community banks' funding costs and the price of credit —
"Rate cuts are definitely a possibility in '24," said Robert Bolton, president of Iron Bay Capital, which invests in community banks. "And that would create some clarity for banks' funding and for the
The S&P U.S. BMI Banks index, which is made up largely of smaller companies, closed out December up 5% on the year after tumbling more than 25% in the spring amid multiple regional bank failures.
The collapses ignited worries about surging deposit costs — following several Federal Reserve rate hikes in 2022 and 2023 to
However, after the Fed paused its rate campaign last summer and U.S. inflation dropped to nearly a third of its 2022 peak, policymakers began to signal that rate cuts were on the horizon, perhaps as soon as the spring of 2024. The BMI Banks index rallied in the fourth quarter in response, gaining more than 20% over the final three months of last year.
The index opened 2024 trading on Tuesday by advancing another 1%.
To be sure, banks' reports due out this month on fourth-quarter results could include discouraging news — analysts anticipate deposit costs to stay high until rates actually tick lower, further tightening net interest margins in the short run.
An S&P Global Market Intelligence analysis of publicly traded banks with under $10 billion of assets found two-thirds posted year-over-year declines in third-quarter earnings per share. Overall, community lenders' median cost of deposits jumped to 1.44% in the third quarter, up from 0.33% a year earlier. The median NIM among these companies declined 4 basis points in the third quarter to 3.37%.
Analysts also are braced for an increase in loan-loss provisions and other credit costs given pockets of vulnerability such as heavily leveraged consumers and vacant office properties in the wake of the pandemic and remote-work trends.
Still, credit quality overall remains historically strong on the whole moving into 2024 and community banks, on average, were profitable in 2023. A boost to profitability this year would generate more earnings-generated capital and bolster banks'
"These are all levers that could create catalysts for bank stocks," he said.
Analysts at D.A. Davidson said in an outlook report that banks with strong or improving capital as well as stable credit quality are poised to outperform.
"While 2023 was a tumultuous year for banks, we think the group is broadly on firm footing entering 2024," the analysts said.
Importantly, the Davidson analysts said, moderately lower interest rates could pull price-sensitive borrowers off the sidelines and strengthen loan demand. Yet rates would remain high enough to increase some banks' overall interest income, given that yields on new loans could eclipse those on years-old credits that mature in the year ahead.
"We anticipate quarterly revenue trends to be positive, as funding costs stabilize and asset yields reprice higher, even with the possibility of a Fed easing cycle," they wrote.
What's more, a dormant residential mortgage market may also regain some vitality. Mortgage rates have already begun to fall, with the average on a 30-year home loan declining from around 8% last fall to 6.6% in the final week of 2023, according to Freddie Mac.
Declining rates in concert with enduring economic strength and a vigorous job market — the economy expanded in 2023 on monthly job gains throughout the year, despite inflation and lofty rates — would propel homebuying and further support the broader economy.
"Rates continue to trend down," said Sam Khater, Freddie Mac's chief economist. "Heading into the new year, the economy remains on firm ground with solid growth, a tight labor market, decelerating inflation, and a nascent rebound in the housing market."
