The financial sector (XLF) took a hit on Wednesday on worry over future profitability after the Federal Reserve raised concerns about the U.S. economy and signaled it is prepared to cut interest rates if necessary.
John Allison, former CEO of BB&T, is warning rate cuts could have a negative impact on the banking sector, telling Yahoo Finance’s “The Ticker” that regional lenders (KRE) are at risk and not well-positioned.
“I don’t think a quarter point move either way matters, but if you get a significant trend to lower rates, that will squeeze regional banks,” said Allison.
An investor note by Bank of America Merrill Lynch published earlier this month echoed this sentiment. According to the bank, if the Fed were to lower rates by 75 basis points by early 2020, large-bank earnings could be impacted by an average of 10%, while profits at some regional banks could be reduced by more. KeyCorp (KEY) could see its earnings drop by 13% while M&T (MTB) could see a 14% decline.
The reason behind the potential drop is that a cut in rates would reduce a bank’s net interest margins, and in turn weigh on profitability.
“I think most regional banks will be better if rates don’t get cut a lot soon,” said Allison. “I think most of them are still squeezed in terms of their margin. The loan demand has still been moderate relative to the economic recovery. They’ve done a pretty good job and have been able to hold down their deposit rates but they’ve had more pressure on that — so I think regional banks would prefer for rates to remain flat or maybe even go up a little bit.”
In terms of the Federal Reserve’s next move, the central bank said on Wednesday that is doesn’t expect to cut rates this year. However, it did forecast one rate cut for 2020.
Seana Smith is the anchor for The Ticker.