Brace for Challenging 2023, Community Banks Told

After a record-breaking year for financial performance for many community banks, 2023 could be significantly harder as liquidity falls and costs rise, according to S&P Global Market Intelligence.

Higher interest rates led to many community banks reporting significant gains for 2022 as yields on their loan books increased. By building up extra liquidity during the pandemic, banks were also able to “resist raising deposit costs” for at least the first half of the year, according to S&P Global Market Intelligence’s report.

However, liquidity fell in the second half of 2022 and is expected to contract further this year. Customers have moved cash out of deposit accounts and into higher yielding products such as money market funds, meaning that banks may not be able to lend as much in the months ahead.

As a result, the S&P Global Market Intelligence report forecast that community banks would rely more on certificates of deposit and borrowing from Federal Home Loan Banks this year, which would increase overall costs.

“Borrowings will begin to feel the impact of substantially higher rates and elevated inflation, leading to normalization of credit trends,” the report stated.

“Credit trends remain benign, but there are signs of weakness in the market, with an increasingly inverted yield curve, which is often a precursor of a recession. Higher mortgage rates have slowed the housing market, and US consumers have largely maintained spending by borrowing more while working through excess savings accumulated during the pandemic.”

A survey of bank and credit union executives conducted by S&P Global Market Intelligence in late 2022 found a significant proportion expected the US economy to be in recession within the next nine months.

A corresponding fall in credit conditions is likely to coincide with banks moving to the current expected credit loss model, which will require them to hold higher reserves to cover for losses over the life of their loan portfolios.

The S&P report said provisions were expected to rise to an average of 11.8% of net revenue in 2023, up from 6.4% in 2022.