Recession Warning Bells Are Ringing. These Banks Look Strong.

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Concern that the economy could be about to shrink is growing, so bank analysts are searching for the best opportunities in the sector for weathering the storm.

Last week, yields on short-dated Treasury debt rose above those on longer-dated securities, marking the first so-called yield-curve inversion in nearly three years. Historically, such moves have been a sign that a recession is on the horizon because they imply that investors are less optimistic about future returns.

Investors are now worried that the Federal Reserve is going to raise interest rates too aggressively as it seeks to slow down inflation. That could push the economy into a recession. 

While an inverted yield curve is considered a sign of trouble for the whole economy, it has more direct implications for banks. The adage is that banks “borrow short and lend long.” They make money on the spread between the interest they pay to borrow—usually in the form of deposits—and the interest they earn on longer-term loans. When the yield curve inverts, there is no money to be made on that differential.

To be sure, that is a simplified version of what actually occurs. Banks certainly don’t like to see an inverted yield curve, but they are able to make adjustments to their lending and borrowing activities as conditions change to mitigate the impact of weaker net interest margins.

It is also worth noting that while an inverted yield curve has been a predictor of recessions, it isn’t a good indicator of when a recession might arrive, or how severe it will be. The last time the yield curve flipped, in 2019, a recession did occur a year later, but it was due to the economic shutdowns spurred by the coronavirus pandemic. Few would believe that the yield curve predicted that. 

Still, Wall Street is weighing what a mild recession would mean for banks. Analysts at

Truist

found a few winners. The firm says that on average, the regional and community banks it covers would see earnings per share fall by 20% in 2023. As profits slide, it said, the banks’ stocks would trade at an average of 14.8 times projected per-share earnings for 2023, up from estimates of 13.1 times forward earnings in 2022. 

The analysts also expect that net interest income would fall by 1% next year following a 2% gain in 2022. Fee income could contract by 3% in 2023 due to weaker economic activity, Truist said. 

The bright spots Truist identified include Merchants Bancorp (ticker: MBIN),,

Cadence Bank

(CADE),

F.N.B. Corporation

(FNB),

Regions Financial

(RF), and

Hancock Whitney Corporation

(HWC). A slowdown is expected to hurt those lenders less than their peers in terms of 2023 earnings, net interest income, and fee income.

Write to Carleton English at [email protected]