It has been almost six months since the crisis in the banking sector erupted with the implosion of Silicon Valley Bank. Subsequently, two more sizable lenders – Signature Bank and First Republic Bank – collapsed amid deposit flight.
But looking at bank stocks, you won’t realize so much time is gone. August turned out to be the worst month since the banking turmoil started in March, as fear gripped the industry. The KBW Bank Index fell 8.8% in August and the S&P 500 Banks Industry Group Index declined 9.5%. On the other hand, the S&P 500 Index lost just 1.5%.
The situation is more dire if we look at the year-to-date performance. So far this year, the KBW Bank Index and the S&P 500 Banks Industry Group Index have lost 19% and 10%, respectively, while the S&P 500 Index is trading in the green, up almost 18%.
Since the early spring, when the turmoil started, investors have been reluctant to add bank stocks to their portfolios as the industry faced ambiguity related to new regulations and the path of interest rates. Concerns related to rising deposit costs and weakening credit, largely in commercial real estate (CRE), also kept investors on the sidelines.
No Respite in August
The month brought fresh worries. The major rating agencies downgraded the ratings of several big and small lenders. The rating agencies – Moody’s Investors Services and S&P Global Ratings – noted that rising funding costs, potential regulatory capital weakness and heightened risks associated with CRE loans on weak office space demand have been testing the banking sector’s credit strength and will, thus, make survival tough for banks.
Another rating agency, Fitch Ratings, wasn’t left behind. Fitch Ratings’ analyst Chris Wolfe said that though slashing of the banking industry’s ratings to AA- from AA in June didn’t lead to ratings downgrades for banks, another one-notch downgrade in the industry ratings to A+ will result in the recalibration of “all our financial measures and would probably translate into negative rating actions.”
Such action will place the industry’s ratings below those of Wall Street giants like JPM and BAC. So, the credit ratings of these large lenders will be cut, leading to a cascading effect, as smaller banks’ ratings will have to be adjusted as well. While noting that the downgrades are uncertain, Wolfe stated that the risks are real.
Further, banking regulators continued to propose new regulations aimed at bolstering the industry’s resilience. In late July, long-awaited capital reforms tied to Basel III were revealed. This would push big banks, including JPMorgan, Bank of America, C and WFC, to adhere to tighter rules.
Then, last month, a new plan for banks with at least $100 billion in total assets was unveiled. Under the proposal, banks will be required to issue adequate long-term debt to absorb losses in the event of a potential seizure. Several regional banks will come under the ambit of this new, stringent rule.
Apart from these, the deposit flight continued during August. Per the data available from the Federal Reserve, since the beginning of this year, deposits at all U.S. banks have declined $371 billion, while balances in the money market funds grew more than $769 billion. This poses a huge challenge for banks, leading to intense deposit competition.
Historically, September is the worst month from a trading perspective. The average S&P 500 performance by month dating back to 1950 reveals that the average return in September is -0.7%.
The trend is likely to persist this time as well.
This month, bank investors look forward to the two-day FOMC meeting for clues on potential interest rate increases at subsequent meetings. The market participants, however, are not expecting any rise in rates in September.
Also, the central bank will disclose their short-term interest rate forecasts for 2023-end.
These developments will have a huge bearing on banks’ performance.
Investors will also be closely following an industry conference hosted by Barclays for updates from banks on how well they are navigating the challenges.
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This article originally appeared on Zacks
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