The Federal Government Is Making Sure Banks Are Prepared for the Worst

On Wednesday, the Federal Reserve is set to release the results of its annual stress test on 32 different lenders, ranging from the largest in the nation to smaller regional banks. Well, joining us now to talk about what's coming for the banking sector and the market as a whole is Rebecca and Gennaro, senior writer at Barons. Rebecca, thank you so much for joining. Thank you for having me. What does this stress test entail? It is a whole matrix of scenarios that they they put the largest banks, JP Morgan, Wells Fargo, Bank of America against. I mean, you're talking, you know, steep declines and the stock market. You're talking a really dramatic rise in unemployment, decline in GDP. And they put the balance sheets against that, of course, including the regional banks, many of which are participating this year that were not participating last year. They're on a two year cycle anyway. This is doomsday scenario. The stress test, the balance sheets against these and say, well, how well can they fare? Can they actually lend to consumers, to households and businesses in these scenarios? Really put that to the test. Of course, following the financial crisis and in recent years they have all come out with a clean bill of health with some, you know, stresses in different areas. But I think the last few years have shown pretty much a clean bill of health for the largest banks. We did see the banks outperform yesterday, but they have underperformed overall in the recent run to record highs certainly for the S&P and the NASDAQ. What's the state of the industry, the health of some of these regionals and bigger banks? Absolutely. You know, it's, it's funny because I was looking yesterday as of the close and the regional bank index is underperforming so dramatically this year. You have the regional bank index, the one that the KBW index down about 12% this year, at least of the close yesterday, the larger bank index up about 7%. What you're seeing right now is, you know, a, a very low to zero chance of any rate cuts this year. Now that should bode well for the banks. However, that lower chance of cuts is eating into earn net interest margins. You saw that as a big focus last earnings season. So I think the the net interest margin pressure plus commercial real estate fears are really hitting the regional banks and the larger banks, but certainly the regionals to a greater extent. I want to talk about the commercial real estate property in a moment and some of these loans as you referenced there. But we did see just a little over a year ago, several mid size well known banks fail and the Fed didn't even really see it coming. Is that still prevalent that concern that reality in the market? Absolutely. It's hard to think that just over a year ago, I mean, there was, you know, a regional banking crisis that claimed several banks. I mean, you do have a couple of new scenarios in the stress test to be released tomorrow that they are testing these banks against partly a wider focus on commercial real estate. I think the the, you know, I think that memories sometimes are very short, but I think that the Fed is taking into consideration the concerns from last year and applying those to the results tomorrow. I think particularly with the regional banks where they're just lending to a wider variety in some cases of these local businesses where maybe the tenants haven't returned. So I think that the CRE concerns are, are, are hotly debated right now, but they're certainly still top of mind for the regionals. Let's talk about some of those loans that you referenced earlier and, and what the issues might be around those. I think it, you know, it, it sounds like the kind of thing we've been talking about for a while, but still it's the return to office. You know, I think that there are still more vacancies than I think that that REITs and some of the larger landlords have have anticipated, you know, this far away from the pandemic. I think that is still a concern that is weighing, you know, I think that it's it's really hotly debated right now. Some analysts, economists say the fears are overblown. You know, people are getting back to work and people are renewing leases, but there is still a lot of concern. I think, you know, Blackstone, for example, has called for a bottom in commercial real estate. They also say that they are, you know, pretty insulated from office loans, but that is still a concern and especially the name of the game is returned to office. And I think that is still a concern that it's not happening as advanced as people thought. Are there any banks that you expect to fail the stress test? I don't, you know, in in researching for, you know, the, the stories that I've written on this, there are no failures expected. It's interesting that you know, in the last few years the Fed has kind of moved away from a pass fail framework and toward a more like nuanced, you know, kind of a bank specific, you know, result set. And I don't, I think that with the regionals, you know, that did not participate last year, there is going to be a lot of scrutiny on them and I don't expect any failures from that. Same with the largest, not expecting any real shocks from there. Interesting. So how credible are these stress tests as seen what we saw take place in the market about 15 months ago, again with the Fed noting that it did not really see this coming, but did act swiftly, this step in with stimulus. Absolutely. I mean, you could look at these and say, well, how useful are they? I mean, because you know, then just a couple months after, if that was in March of 2023 and then the stress tests were in June of of 2023, everything passed. I mean, you know, it wasn't. And the larger banks were insulated from a lot of that stress. However, it is just hotly debated how useful are these scenarios. And I think the Fed will continue tinkering with them. You know, every year there's slightly different scenarios as far as stock market, stock market declines, unemployment rising a little bit, but that is subject for debate. You know, I, I can't call whether they're so, you know, useful or not, but I think that is there's a lot of criticism of the tasks that they don't capture everything. Interesting. So we've been talking about this to some extent from an investor mindset. What about a consumer mindset when they think about shopping around for banks in a bank that might be a right fit for them? How should they interpret these results? Absolutely. I think that it is a it is a good indicator even though it's debated, you know, how how strong is this an indicator of, you know, the individual banks health overall things lying under the surface for consumers? I think, you know, and you're seeing a bifurcation and consumers overall right now where, you know, the richest of them are doing well, the, the the wealthiest, but then you are seeing some strain on the lower end consumer credit card delinquencies rising. I think that it's a good indicator still of where the economy is, but there's still a lot going on under the hood that these stress tests will not capture. But I think that when you're looking for, you know, I, I think a lot of people are looking for the highest rates they can get on their C DS and, and high yield savings account. And I think those remain elevated. I think the, the, the stress test will remain a good indicator overall of where the economy is. If rates do remain higher for longer, what does that mean for a small, medium and large size bags? It's hard because you are seeing, you just are seeing that stress. I keep bringing up commercial real estate, but it is going to be harder for some of these loans to, I mean, not enter, you know, a delinquency. I think that, you know, private credit is a huge issue right now. If rates remain high and there are some stresses with the way the banks are lending to their to their clients, then you will see some more private credit possibly move in and try to take some of that market share as is already going. So I think that's an important part of the equation here. Interesting, Rebecca, we appreciate the time. Thank you so much for your big event. Rebecca is a senior writer at Baron's.