Bank stocks stall as profitability faces new threat

Bank investors retreated this week, discouraged by lenders’ warnings about the negative impact of falling interest rates.

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

The selling came after major banks reported fresh headwinds. Financial stocks fell broadly because large banks often prove to be benchmarks for smaller institutions, especially when it comes to bread-and-butter loans.

During the week JPMorgan Chase has softened its earnings forecastsaying he expects the Federal Reserve to cut interest rates, while potentially positive for banks over the long term, could result in loans being valued lower than deposits sooner. That could hurt net interest margins and profitability for JPMorgan’s $4 trillion in assets, the New York firm’s CEO, Daniel Pinto, said at a Barclays conference.

“It is clear that as interest rates fall, the pressure on deposit prices decreases,” he said.

At the same conference, Ally Financial expressed similar concerns.

Chief Financial Officer Russell Hutchinson said the $193 billion-asset company has about $60 billion of floating-rate assets that will be lower the price immediately as interest rates fall. It will take some time, he said, for the cost of deposits to catch up.

This was compounded by continuing concerns about an economic slowdown and the possibility of an increase in credit losses.

“There are always winners and losers when interest rates change,” Steve Foerster, a finance professor at Ivey Business School, said in an email. In the short term, “lower interest rates benefit borrowers and hurt lenders… They’re really two sides of the same coin.” But over time, he added, it’s “more nuanced.”

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

“Yes, there are issues that we have to address as interest rates go down, but it’s about finding a balance,” Stevens said in an interview. “We’re always dealing with these changes. It’s a challenge, but I don’t think it’s a problem on a larger scale.”

Of course, there is no panic in the market. Bank shares are up about 12% since the beginning of the year.

Stevens added that if the Federal Reserve were to cut interest rates gradually over several months, banks could adjust methodically.

Andrew Husby, senior U.S. economist at BNP Paribas, said that given current conditions, this was the most likely scenario.

He expects policymakers to “hold back on larger cuts of 50 basis points to start the process. Our baseline scenario assumes 25-basis-point cuts at each of the last three policy meetings this year, provided the labor market shows no clearer signs of deterioration,” Husby said in an email.

The Fed meets next week and is expected to announce a rate cut on Wednesday. The central bank raised rates at the fastest pace in four decades, between March 2022 and July 2023, to a range of 5.25% and 5.5%. It kept its target rate at that level to tame inflation, which has soared amid supply-chain disruptions from the pandemic, government stimulus and Russia’s invasion of Ukraine. The higher rates have raised banks’ costs of deposits while slowing demand for loans.

Mark Valentino, head of business banking at Providence, Rhode Island-based Citizens Financial Group, which has a net worth of $220 billion, said the steadily but slightly lower borrowing costs should benefit lenders, including community banks, as they serve small businesses.

“Whatever the Fed says about the pace of reduction is probably more important than the first cut itself,” Valentino said in an interview. “If the Fed shows a path of declines over the next 12 months, that would be a positive indicator for small businesses.” In addition to making existing variable-rate loans more affordable, “small businesses can start making informed capital plans for the coming year. There’s a lot of pent-up demand for loans,” which, if unleashed, could bolster bank profits.

Inflation fell to a three-year low in August, the Bureau of Labor Statistics reported. After surpassing 9% in 2022, the federal consumer price index rose 2.5% year-over-year last month. That was within the Fed’s 2% target.

US Federal Reserve officials have been saying for the past few weeks that they intend to focus not on inflation but on supporting job growth and economic expansion.

The Department of Labor reported that U.S. employers have added 142,000 jobs in August and the unemployment rate fell to 4.2% from 4.3% in July. But the government also revised down its June and July reports by a combined 86,000 jobs, and the pace of employment growth fell from its previous 12-month average of above 200,000.

U.S. gross domestic product, the broadest measure of economic activity, rose 3% annually in the second quarter, according to the Bureau of Economic Analysis. But the Atlanta Fed’s updated estimate on Friday growth in Q3 slowed to 2.5%.