In the fourth quarter of 2023, US banks experienced a significant decline in profits, with a 44 percent decrease compared to the previous quarter. This decline is attributed to several factors, including ongoing economic and geopolitical uncertainty, inflationary pressures, volatility in market interest rates, and emerging risks in commercial real estate portfolios. The Federal Deposit Insurance Corporation (FDIC) warns that these issues, along with funding and earnings pressures, will continue to be areas of concern for the banking industry.
The decline in profits was particularly driven by non-recurring, non-interest expenses at large banks, which may refer to the special assessment fees they had to pay to the FDIC. After the failures of Silicon Valley Bank and two other financial institutions, the FDIC’s deposit insurance fund suffered a loss of $16 billion. To recover these losses and replenish the fund, banks were directed to pay special assessment fees. In total, the nation’s largest banks were expected to pay $15.8 billion over two years.
Lower interest income and higher provision expenses also contributed to the decline in banking profits. The net interest margin (NIM), which measures the profitability and growth of banks, fell by two basis points to 3.28 percent in the fourth quarter. This decrease was primarily due to the increase in deposit and non-deposit liability costs outpacing the increase in asset yields.
Furthermore, noncurrent loans increased by four basis points to 0.86 percent, indicating that more loans were 90 days or more past due or in nonaccrual status. Additionally, loans that were 30-89 days past due spiked by seven basis points. Credit cards and nonfarm, nonresidential commercial real estate loans were the main drivers of these increases.
Despite these challenges, there were some positive indicators. Domestic deposits grew for the first time in seven quarters, suggesting that individuals and businesses are placing their trust in banks. Additionally, unrealized losses on securities decreased by 30 percent from the previous quarter.
Looking ahead, the FDIC has released its 2024 economic scenarios, which will be used in upcoming stress tests for banking institutions. Stress tests were introduced after the 2008-09 financial crisis to determine the amount of capital banks need to be considered financially healthy and assess their ability to return money to shareholders through dividends and buybacks. The most severe scenario in these tests will examine how banks will fare in a situation where home prices decline by 36 percent, commercial real estate prices decrease by 40 percent, and the unemployment rate jumps by 6.5 percentage-points.
Investors will closely watch the stress test results, set to be released in June. While banks claim they are well-prepared to pass these tests, it remains to be seen how they will fare under severe economic conditions.
In terms of credit quality, the FDIC’s Shared National Credit (SNC) program found that the credit risk of large syndicated banks remains moderate. However, there has been an increase in risk due to higher interest rates affecting leveraged borrowers and compressed operating margins in certain industry sectors. Industries such as technology, telecom and media, health care and pharmaceuticals, and transportation services are particularly vulnerable to these risks. In the real estate sector, risk is segmented, with some subsectors showing deteriorating trends.
The FDIC emphasizes that borrowers’ ability to manage through shifts in interest rates and other external factors will impact the magnitude and direction of risk in 2024. Highly leveraged borrowers without financial flexibility may face challenges in maintaining their financial performance and repayment capacity.
Overall, the decline in US bank profits in the fourth quarter of 2023 highlights the challenges faced by the banking industry. Ongoing uncertainties, inflationary pressures, and risks in commercial real estate portfolios pose significant downsides for banks. However, there are also positive signs, such as the growth in domestic deposits. As the industry awaits the stress test results and navigates through shifting economic conditions, it remains to be seen how banks will adapt and perform in the coming months.
