REAL ECONOMY BLOG | February 06, 2023
Authored by RSM US LLP
Despite the lift in financial institutions’ net interest margins from unprecedented rate hikes, the headwinds facing the industry through declining macroeconomic conditions are creating unique downside risks for the nation’s banking system.
Still, the strong capital positions of the nation’s banks have positioned them to weather such headwinds if they prioritize accordingly. Here are four areas to pay attention to as the year progresses.
Net interest margins
The NIM expansion financial institutions saw during 2022 due to the aggressive rate hike campaign from the Federal Reserve is beginning to stall as deposit repricing looks to compress NIM in 2023. The activity has instigated conversations surrounding repricing risk on both sides of the balance sheet. Further clouding this issue is the uncertainty surrounding the Fed’s intentions regarding a rate pause and hold. While a majority of economists expects the rate pause to occur mid-2023, the length of time the Fed holds rates steady will present unique challenges to pricing strategies.
With top-line revenue growth slowing, institutions will likely shift their focus to cost management or mitigation strategies to maintain their overall profit margins. Automation and other technologies can play an important role here.
Despite the lift in financial institutions’ net interest margins from unprecedented rate hikes, the headwinds facing the industry through declining macroeconomic conditions are creating unique downside risks for the nation’s banking system. Still, the strong capital positions of the nation’s banks have positioned them to weather such headwinds if they prioritize accordingly.
Loans and deposits
Market concerns about the high-inflationary environment in 2022 fully suppressing loan growth did not entirely come to fruition. Facing deposit outflows, banks will need to focus greater effort on retaining their deposits to continue lending into a cautionary period.
Outstanding loans increased in 2022, with total loans and leases reaching double-digit growth of 10%. This growth is more than double the amount experienced in any of the last 10 years, but it shouldn’t be misconstrued. The increase is propped up by specific segments such as the commercial and industrial (12% growth), consumer (11% growth) and multifamily (18% growth) segments, whereas home equity lines (0% growth) acted as an anchor in 2022. Mortgage lending in particular shows a significant slowdown, with originations dropping by 55% in 2022.
Growth will be hard to sustain without the steady inflow and support from deposits. With the anomaly of the pandemic, stimulus money helped propel consumer savings to a high of $2.5 trillion. Total deposits experienced growth through the first quarter of 2022, where they peaked at $19.9 trillion, and have declined each quarter since.
Although the decrease in deposits has been rather limited to date (Q3’22 shows a decline of 1% quarter over quarter), the expectation is that this trend will continue into 2023. Many institutions are on the lookout for alternative funding sources, with Federal Home Loan Bank advances coming in as the forerunner, showing a 136% increase in 2022.
Capital and liquidity
While rapidly rising rates bode well for loan interest income, they can have adverse effects on an institution’s capital and liquidity structure. Notably, the rate environment has caused unrealized losses on available-for-sale securities to balloon, resulting in a risk to capital levels.
The net unrealized losses reflected on bank balances were reported at $348 million as of Q3’22, an increase of 37% quarter over quarter. The year-over-year change from an unrealized gain on investments to unrealized loss checks in at a staggering 3,068%. Currently, accumulated other comprehensive income is sitting at an all-time historical low for FDIC-insured banks.
The impact of this change in unrealized positions on the investment portfolio can be clearly seen in capital ratios. The total risk-based capital ratio for banks within the United States has decreased by 5% in the past year. While there’s no immediate cause for concern as there is still a buffer between actual ratios and Basel minimum requirements, it is something institutions are shifting their attention to.
Current credit conditions are unique when compared to historical events. For example, the hardships resulting from the 2008 collapse led financial institutions to tighten their underwriting standards. This has greatly strengthened their asset quality, resulting in sound credit with limited deterioration flowing in.
The industry net charge-off percentage was sitting at a historical record-low of 19bps as of Q4 2021 and has stayed at a consistent level since then. Additionally, traditional metrics analyzed in light of credit deterioration have not yet shown signs of weakening, as past dues, nonaccruals, and criticized loans are also sitting at near-record lows in 2022.
Consumer lending is the one area where we will most likely see more deterioration compared to other segments. In 2021, consumer savings were fortified and past dues on consumer loans hit a 10-year low. However, savings dwindled in 2022, a trend now evident in the consumer portfolio as we see a corresponding double-digit increase in past dues.
Once we see more prominent movement in consumer lending, we would expect to see slight deterioration seep into other segments as well, especially real estate. Institutions should be mindful of exposure sitting within their portfolios, as risks differ depending on where borrowers reside, borrowers’ business operations, and the volatility in rates.
This article was written by Angela Kramer, Brandon Koeser and originally appeared on 2023-02-06.
2022 RSM US LLP. All rights reserved.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
LaPorte is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.
For more information on how LaPorte can assist you, please call 713.548.2034.