In a recent episode of Fitch Ratings’ Fixed Interest Podcast, Christopher Wolfe, managing director and head of Fitch Ratings’ North American Banks team, discussed the state of U.S. banking with host Justin Patrie, head of Fitch Wire and senior director at Fitch Ratings, exploring key trends from 2024 and expectations for the year ahead.
Banking Sector Performance in 2024
Q: What have been the major trends for U.S. banks this year?
Christopher Wolfe: After what I think was a somewhat turbulent 2023, 2024 has been, so far, much calmer by comparison. I would say the key issues for U.S. banks have been improving interest rate risk management, gearing up for more stringent capital requirements, and addressing asset quality concerns in certain loan portfolios, namely commercial real estate and, to a lesser extent, some of the consumer loan funds.
Earnings and profitability have been a mixed bag so far. While banks have benefited from higher rates, this in turn has caused loan growth to be sluggish and also increased unrealized losses from securities.
Q: How have bank credit ratings evolved during 2024?
Wolfe: Generally, ratings have mostly stabilized during 2024. About 80% of our rating outlooks are stable, and there’s a balance between positive, which is around 10%, and negative, which is about 10%.
If we look at, say, last year, things were decidedly more negative, and there were far more negative outlooks, which were about 25 of our rated universe, and very few outlooks on positive. Following our more recent round of regional banks, which we just completed this month, there was actually one rating upgrade. One percent outlook was revised to positive, and one outlook was revised back to stable from negative.
Regulatory Environment and Capital Requirements
Q: How has the regulatory landscape evolved in 2024?
Wolfe: I’ll start with the Basel endgame capital proposal, because I think those are probably the most impactful item on the regulatory agenda, regardless of the outcome of the elections.
The proposal was met with a significant backlash from a number of quarters, and obviously the banks themselves, but there were others such as housing advocacy groups, and Congress as well was rather skeptical of the proposal. If you look at the comment letters on the proposal, they were decidedly against it, and the agencies ultimately had to extend the comment period.
Things were quiet for a little while until about this past September, early September, when the vice chair for banks provision, Michael Barr, made a speech previewing what were expected reductions to the capital requirements from the proposal, and estimated that these would come down by half from the original.
Q: What developments are expected for Basel endgame capital proposals?
Wolfe: Even with the reduction in the capital proposal, we still see this as improving bank capital adequacy, especially if you close the loophole for the category three and four banks where they can exclude the unrealized losses in capital.
Based on our analysis and assuming a typical phase-in period, our rated banks think they’ll be able to comply with the requirements. So, from that perspective, we see this as relatively neutral.
Post-Election Policy Implications
Q: What banking policy changes might emerge after the election?
Wolfe: If we look at a Trump 2.0 administration, a couple of things would come to mind, which is, one, we think a more derogatory stance would emerge, as it did during his first administration. First, I think the pace of new rulemaking comes to a crawl. We think a Trump administration would be more accommodating towards bank M&A.
I would also note that under the first Trump administration, there was a view of allowing more financial innovation, such as crypto and fintech, to take root. And we would probably see a more relaxed tone, again, for crypto and fintech.
Q: How might different administration scenarios affect bank regulation?
Wolfe: Lastly, I would also highlight Fannie Mae and Freddie Mac, which remain under conservatorship where they were placed in October 2008 during the global financial crisis. During the first Trump administration, there were plans actually to release the enterprises from conservatorship, although this was not completed prior to the end of his term. We shouldn’t be surprised to see this pursuit again.
Lessons from the 2023 Banking Crisis
Q: What did the events of March 2023 reveal about bank liquidity management?
Wolfe: Liquidity is a funny thing. It’s almost always there when you don’t need it but it’s hard to get when you do. We characterize the events of March 2023 as more of what we call a crisis. So it’s a stress for most, but a crisis for a few.
When you think about the banks that were most caught out or affected, like SVB, Signature or First Republic, they were, in fact, material outliers in terms of their deposit structure and with very high concentrated reliance on uninsured deposits, as well as having large unrealized losses in their securities portfolio.
Q: How have banks adjusted their approach to deposit management?
Wolfe: Banking is always a confidence game, and what looked at first like a liquidity event turns out to have been more of a view on solvency for some of these banks.
One of the problems banks ran into was operational constraints in terms of accessing the federal home loan banks and or discount window. And so, you have collateral, but you can’t easily move the collateral between the two. And so we are seeing banks test their access more regularly and position more collateral at the Federal Reserve in the event of liquidity stress.
The March experience revealed the importance of understanding the composition of deposits, particularly insured versus uninsured and operational versus non-operational. The insured deposits and the operational deposits proved to be a lot stickier than the uninsured and the non-operational deposits. That’s an important lesson that I think a lot of banks learn, and it makes sure you’re not over-reliant on the more uninsured and/or non-operational deposits.