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Macro-Environment to Weigh Heavily on U.S. Banks in 2020

November 26, 2019, 08:59 AM
Filed Under: Banking News
Related: Fitch Ratings

The ratings and sector outlooks for U.S. banks, while stable, reflect the weakening economic operating environment evidenced by a flat yield curve and declining business confidence, as well as the effects of the Fed's loose monetary policy and a protracted trade war, says Fitch Ratings. U.S. growth, while slowing, is still expected to outpace that of other developed markets. Moreover, banks are benefiting from solid liquidity positions and deposit profiles, particularly at the larger, more capitalized institutions.

Given macro pressures, broad rating upgrades are unlikely in 2020. However, rating actions skewing toward negative next year would be unsurprising as Fitch remains sensitive to how banks respond to an evolving regulatory and slower economic environment. Increasing risk, particularly during the late stage of the credit cycle to boost returns while eroding liquidity and capital, would be viewed negatively from a ratings perspective, as would outsized deterioration of asset quality.

Trade uncertainty and slowing global growth continue to weigh on business confidence and mute commercial loan growth at large U.S. banks. A further softening of the economy could be exacerbated by high corporate debt levels, with material growth of shadow banking and other forms of non-bank financial lending having potential negative knock-on effects to U.S. banks.

Thus far, asset quality remains benign, with nonperforming loans and net chargeoffs for the industry below historical averages for all asset classes, which are expected to normalize over time. Unlike business sentiment, consumer sentiment remains solid, with low unemployment, both of which are catalysts for expected consumer credit expansion in 2020.

Fitch expects U.S bank operating performance in 2020 to see less upside as the benefits of expense initiatives and a benign credit environment begin to wane. However, earnings headwinds and margin pressure could be partially mitigated if banks are able to lower funding costs, particularly for commercial and wealth deposits.

While Fitch expects some continued reduction in capital ratios across the industry, we also continue to expect levels to stabilize for the large banks during 2020 as many are close to or have already reached their longer-term targets. Moreover, Fitch expects the January 2020 implementation of current expected credit loss (CECL) accounting to be manageable in the context of capital generation capabilities and expected near-term balance sheet growth. Reserves to total loans should increase by around 0.40% to 1.8% on average for large U.S. banks, as CECL is expected to increase loss reserves at consumer loan-focused banks by at least 50%, while large commercial banks are expecting an average increase of around 27%.

Spending on digital innovation should continue to accelerate during 2020 with large banks leading the charge. Fitch estimated the average technology spend (including spending on day-to-day operations and innovation) at $8bn in 2018 for the large U.S. banks, which should modestly increase during the new year. While smaller banks can be "fast followers" or buy off-the-shelf solutions, more M&A transactions over the near term are expected as smaller banks find it more difficult to stay technologically relevant.

Among the most unpredictable of operational and financial risks for financial institutions is the growing potential for cyberattacks. Fitch sees cybersecurity as one of the most significant emerging risk areas for financial institutions, and increasingly relevant in bank risk control frameworks amid growing regulatory concern. Negative rating actions could result from a cyber event due to lack of risk controls resulting in an outsized regulatory fine, compromised data and/or any longer term reputational damage, which could weigh on financial performance over time.

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