Resilience and Stress in the Banking Industry

The banking industry, while resilient, is starting to show signs of stress, as highlighted in a report released by the Federal Deposit Insurance Corp. (FDIC) on Thursday.

Decline in Earnings

According to the FDIC, second-quarter earnings for U.S. banks reached $70.8 billion. While this figure represents an 11.3% decrease from the previous quarter, it is important to note that this decline can primarily be attributed to the failure of Silicon Valley Bank and two other institutions during the spring. If we exclude these bank failures, profits would have remained steady quarter-over-quarter and been 5.7% higher compared to the same period last year.

Profitability Concerns

Despite recent earnings figures, signs of potential profitability concerns within the banking sector have emerged. The initial impact of the Federal Reserve’s efforts to raise interest rates over the past year and a half had proven beneficial for banks, as it allowed them to generate higher returns on their interest-earning assets. However, as rates continue to rise, banks face increasing pressure to satisfy depositors’ demands for higher yields, while also grappling with rising funding costs. Consequently, the net interest margin at banks experienced a decline of three basis points, settling at 3.28% during the June quarter in comparison to the first three months of the year. This decrease follows a prior decline of seven basis points in the first quarter. Nonetheless, it is worth noting that the net interest margin remains approximately 0.5 percentage points higher than the previous year and slightly above the average margin of 3.25% before the pandemic.

In conclusion, while the banking industry has shown resilience in the face of challenges, there are indications that stress is starting to take its toll. Factors such as bank failures and declining net interest margins highlight potential concerns over profitability. Monitoring these trends will be crucial for understanding the future trajectory of the sector.

Banks Face Challenges Amid Rising Interest Rates

Higher interest rates have had a significant impact on banks, leading to various consequences. According to the FDIC, there has been an 8.3% increase in unrealized losses on securities, amounting to $558.4 billion during the prior quarter. Throughout the pandemic, when loan demand was low and banks had excess deposits, they allocated capital to fixed income investments, primarily bonds backed by the U.S. government. However, with rates rising rapidly, the value of these bonds plummeted.

Consequently, this spring saw problems emerge within the sector as depositors began withdrawing their money from certain banks in search of higher yields, ultimately forcing these banks to realize those losses. Although deposit outflows continued for the fifth consecutive quarter, the pace has “moderated substantially” compared to the first three months of the year, as stated by FDIC Chairman Martin Gruenberg on Thursday.

Despite this positive trend, Gruenberg remains cautious about the challenges that banks still face due to inflation, higher interest rates, and geopolitical uncertainty. In fact, several banks have recently experienced credit downgrades by ratings firms due to these concerns.

Gruenberg emphasized that “significant challenges” persist for banks, particularly with commercial real estate fundamentals, especially in office markets, as well as funding levels and net interest margins. The FDIC will continue to closely supervise and address these matters.

On Thursday, bank stocks experienced a slight decline, with the SPDR S&P Bank ETF (KBE) down by 1%, while the S&P 500 fell 0.4%.