A Return to Normalcy
Like many in the industry, Tom Michaud sees the December decision by the Federal Reserve to pause increases to the federal funds rate as a positive sign.
If the Fed achieves a so-called soft landing and eases rates later this year, banks can look forward to higher earnings, according to the CEO of the investment bank Keefe, Bruyette & Woods. But that will take some time.
“We actually believe in 2024, net interest income for the year will be down … because there's not a lot of loan growth,” he says. Earnings should improve by year-end. “We think the industry's interest rate exposure and [bank] balance sheets will have caught up.” And that environment could represent a return to normal for the banking industry, Michaud adds.
But that could look different from what the industry has experienced over the years since the 2007-08 financial crisis. In fact, by looking at two key indicators, one could argue that we’ve been living in abnormal times since that event.
The federal funds rate influences the interest rates banks can charge on loans and pay out to depositors. Before the Fed began its series of rate drops to ease the financial crisis, the effective federal funds rate was 5.27%; in the pre-crisis period from 1990 through 2006, the federal funds rate averaged 4.35%.
From 2008, when the Fed dropped that rate to effectively zero, until the agency began raising rates in mid-2022, the federal funds rate averaged just 0.51%, spending most of those years hovering just above zero. Today, the fed funds effective rate exceeds 5% — not too far above the historical average of 4.6%.
Likewise, net charge-offs — a measurement of asset quality — inched up to 0.5% for the industry as of the third quarter 2023, from an average 0.46% over the last decade. That average was just a bit higher, 0.73%, in the 16 years before the financial crisis.
Michaud expects to see more credit losses in 2024. “The shocker should not be that credit expense is going up,” he says. “The shocker is it's been zero for so long.”
Banks have been setting aside more for expected loan losses, and Michaud says not to count banks out.
“The banking industry is under a lot of pressure at the moment,” he says, “but it's not down and out.”
• Emily McCormick, vice president of editorial & research for Bank Director