Every time the Fed starts hiking, Wall Street plays the same parlor game: what breaks? Last cycle the answer was regional banks — Silicon Valley Bank had parked cheap deposits in long, low-yielding bonds, yields jumped, the bonds cratered and the depositors ran. A few years on, with the Fed raising again and the 10-year above 5%, bank stocks are trading as if the sequel’s already in production. Telis Demos, in Tuesday’s Heard on the Street, checks the script against the balance sheets.
Start with the hole. Banks’ unrealized losses on securities were just under $330 billion at the end of the second quarter, FDIC data show, and they’ve surely grown since as yields rose. But the hole is shallower relative to the walls around it: those losses equal around 14% of Tier 1 capital, down from over 33% in the third quarter of 2022. Banks have added capital, and the bond books have shrunk and shortened — securities with at least four years left to run were over 20% of assets in 2021 and under 16% by midyear, per BankviewUSA.com. Shorter bonds move less when yields move, and the losses they do carry come due faster.
The other side of the ledger has quietly turned in banks’ favor. In 2021, loans due to mature or reprice within three months made up less than 20% of bank assets — the first time that had happened in at least two decades — and by midyear the share was back above 25%, lifted by lending to private-credit funds and, more recently, to businesses. Floating-rate loans reprice with the Fed, which is why analysts polled by Visible Alpha expect net interest margins across the KBW index to rise this quarter and again next year.
So why is the index down almost 9%?
Because investors are skipping ahead to the part of the cycle that hurts. The KBW Nasdaq Bank index has dropped almost 9% in the past month while the S&P 500 eked out a gain. The worries aren’t bond math; they’re deposits — banks say the fight for savers’ cash is already fierce, and the latest fear is that AI agents will do the shopping around that inertia used to prevent — and borrowers who took on debt priced for a cheaper world. Demos’s close: the cycle may yet deliver more upside than down, but bank investors may be too skittish to stick around and find out. We get the first evidence within days, when the biggest banks open third-quarter earnings season.
Our read
Investments/Risk (IN04). This is a story about what changed since the last fright, and the honest answer is: a lot, at the big banks. Shorter bonds, more capital, more floating-rate loans — that’s a balance sheet built for higher-for-longer, which is also the balance sheet everyone was begging for in early 2023. The house holds JPMorgan (JPM) in 26 model books, Goldman Sachs (GS) in 19 and Bank of America (BAC) in 11, all at weight, nothing added, and Wednesday’s tables have the KBW Bank index up just 3.9% this year against 14.2% for the S&P 500 — unloved, not unowned. Our stance is hold, not hunt: a 9% monthly slide ahead of earnings isn’t a reason to add bank exposure, and it isn’t a reason to sell what’s there, either.
The planning point is on the other side of the teller window. Higher-for-longer is a gift to savers who move and a tax on savers who don’t — and the banks’ own fear, per Demos, is that you’ll finally move. So be the deposit they’re worried about: compare what your cash earns with the 13-week bill’s 4.050% auction yield in Wednesday’s money-rates table, and don’t let inertia subsidize a bank’s margin. Then, if you own bank stocks or a financials fund, write down why before the earnings land — that way the numbers tell you something instead of telling you what to feel. Check the roof on a dry day; rates look like they’re staying high for a while.