Bank On This
🚀 The quick version: We have been getting a lot of questions from readers about all of the recent bank headlines and what it means for your investment accounts.
Let’s quickly recap what’s going on:
Regional banks go under. Earlier this year we saw three regional bank failures (defining terms: regional banks hold between $10 billion and $100 billion in total assets, community banks hold under $10 billion and large banks hold over $100 billion). These bank failures were contained as larger banks stepped in to gobble up most of the assets at bargain prices and the government assured us they were there to help. Everyone seemed to move on thinking the issue had been put to bed.
Moody’s signals it’s not over. Moody’s (one of the three main credit agencies in the U.S. - the other two are Fitch and S&P) recently chimed in stating the banking sector is not “all clear” and downgraded the credit rating of 10 community and regional banks (translation: when a bank’s credit rating is lowered, this is another way of saying the rating agency views them as more risky).
The timing is peculiar as the downgrade happened several months after the regional bank failures, leading us to initially think some of it was just a delayed reaction. While we still think this to some extent, Moody’s highlighted several risks with these 10 banks that speak to a more cautious outlook (one of them being their over exposure to a commercial real estate sector that is seeing more an more weakness - especially in large cities).
Fitch might be next. Now all of a sudden Fitch announced this past week they are thinking of downgrading not just a few banks, but the entire banking sector citing some of the same risks as Moody’s but also noting that the rapid rise in interest rates is hurting every type of bank.
The reason rising interest rates can hurt banks is that most make money by long term lending (think mortgages) and also parking spare cash in safe investments (like long term Treasury Bonds) which offsets any interest payments they have to make to customers (like savings accounts or certificates of deposit). As interest rates rise quickly, they have to adjust upward the interest they pay customers in real time while still being locked in to longer term loans outstanding at lower rates which creates a profit crunch.
Regulation next shoe to drop. Adding to this pressure, the government has decided to finally react to the earlier regional bank failures by proposing new regulations (to take effect likely later this year). One of the key regulations will require banks to hold more money in reserve just in case things go south. While an obvious idea in theory, this new regulation coupled with the mix of forces above will create an environment that may actually further pressure the banking industry over the next 6-12 months.
Here’s why:
Banks will need to raise money from investors (or lend less) in order to meet these new government reserve regulations (likely later this year / early next).
If they are all downgraded by Fitch, investors will demand higher interest payments because they will be deemed a more risky (this will already apply to the 10 banks downgraded by Moody’s).
Higher interest payments will pressure profitability and banks will need to need to cut expenses or find other ways to make money (ex. raise loan rates, raise fees, lay off workers, or find other ways to save) to maintain profits.
👪 How it affects your family: Changes in the banking system are always worth paying attention to. Here are some ways families may be affected and actions you can take to be prepared:
Watch your investments. If you currently own bonds of any bank or financial institution, the value of that bond on paper will go down if Fitch decides to go through with a downgrade. Check your portfolio or ask your advisor about any exposure you may have to the bonds of financial institutions so you are at least aware of this potential risk and can decide what (if anything) to do.
Call your bank and make sure your accounts are FDIC insured. Most banks and U.S. financial institutions are FDIC insured up to $250,000 (this usually also includes CDs or multiple types of savings accounts but make sure). This means even if your bank were to cease to exist tomorrow, the U.S. Government would pay you what’s in your account up to $250,000. Call your bank today and ask specifically about your accounts to make sure you are covered so you can be ready for even the worst scenarios.
Watch out for increased fees ands higher loan rates. As noted, with banks likely having to pay higher interest rates to investors while dealing with more regulation, they will need to make up that extra cost somewhere. Each bank will be looking at all of their costs closely over the next several months and we would bet several choose instead to just increase fees or loan rates as a solution. Usually, but not always, we would say the larger banks would be increasing fees less than the smaller ones as the larger banks are in a better position to absorb slightly higher costs for a period of time (should you want to move your account). Regardless, start looking at your monthly bank statements carefully, ask questions if you spot something that looks off, and check out our guide of 10 common fees banks use and how to avoid them.
