All eleven regional banks in the S&P 500 reported earnings last week. The result was stock price rises across the board, signaling investor enthusiasm – or, at least, relief. As reported by The Wall Street Journal, “Big Regional Banks Reported Stable Deposits. For Investors, That Counts as Great News.”
“Many investors entered the second-quarter earnings season expecting the worst for regional banks. But that didn’t materialize in the results released this week—at least not for the bigger players.”
The main investor concern was that larger depositors would have shifted to larger banks or alternate financial firms or investment funds. For the most part, though, they didn’t. Without additional bad news, the troubled organizations like Silicon Valley Bank now look like exceptions, not omens.
So, hurdle #1 has been cleared. Now comes all the other adverse issues facing the regional banks:
Net interest margin (NIM) shrinkage – The need to increase interest payments on money market, savings and time deposits to attract and retain them. To the extent some of a bank’s assets are in lower-yielding loans and bonds, the “net” will shrink as deposit yields rise.
Deposit erosion – Yes, the last couple of months didn’t see large, panicky depositor exits. However, the less robust characteristics of regional banks (vis-a-vis the major, national banks) mean the memory of the recent problems could lead to future transfers out. Most people are slow to act when financial things go awry.
Lower lending – The potential economy slowdown means fewer loans (and their higher interest income)
Commercial real estate problems – Real estate loans have their own set of problems beyond the potential economy slowdown. Many commercial real estate markets are in weak states due to vacancies, soft pricing, financial leverage, and higher rate refinancing.
Increased reserves for bad debt – A potential economy slowdown and the real estate problems mean a rise in credit risk and the possible need for more reserves
New banking rules and regulations – There is work afoot to control the causes of the recent regional bank mini-crisis. New rules and regulations will likely constrain some income-earning actions
Earnings decline – Add to all those issues above the fact that inflation continues to push costs up, eating into the profit margin. Obviously, that means earnings will decline if management cannot increase revenues and/or reduce costs
Dividend cut? – If earnings do decline and the lower level is viewed as more than a one- or two-quarter affair, expect the board to cut the dividend payout
The bottom line: A bad times reprieve is not a cause for optimism
To return to a period of health and growth, the causes of the bad times must be countered, thereby ending the adverse results. Importantly, this cure doesn’t mean everyone comes out whole. It simply means the banking environment has returned to normality, so good bank management can produce good results.
How long before regional banks will be in such a period? Probably not until inflation and interest rates stabilize, the economy regains a sound footing, and regional banks are viewed as healthy.
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