Banks leaving the pain of 2020 behind

Banks are looking ahead to 2021 with the hope that the human and economic toll of 2020 can be left in the past.

Few could have expected such a difficult year for banks; after all, they were coming off a record year for earnings in 2019, and the future seemed bright. But then in March, they were confronted by a global health pandemic that sent the economy into a tailspin, prompting the Federal Reserve to cut the federal funds rate twice, to zero, and Congress to step in with a fiscal aid package.

The effects of these cuts fell squarely on the banks, which depend on interest earned from loans for a majority of their income. The result was that their net interest margins were compressed to record lows, according to the Federal Deposit Insurance Corporation.

But in late December, President Trump signed a $900 billion fiscal aid package to provide direct fiscal aid to households and businesses equal to 4.25% of gross domestic product. This package, the second-largest economic aid measure in the nation’s history, was expected to give a much-needed boost of fiscal relief to the economy, just as the novel coronavirus was surging again.

“We expect the aid package will bolster U.S. growth conditions in the first half of 2021, likely preventing another economic downturn, which our forecast had previously implied,” RSM US Chief Economist Joseph Brusuelas stated.

Because of the coronavirus relief package, the continuing distribution of a vaccine and the growing prospects of further stimulus given Democratic control in Washington, D.C., RSM revised its forecast for first-quarter growth in 2021 to 2.5%, up from 1.1%, and an increase in second-quarter growth to 8.7% from 4.6%.

Further, as the economy continues to recover, all signs point to robust growth in the second half of the year. RSM forecasts year-over-year growth in gross domestic product for 2021 of roughly 5.4%, with risk to the upside. After the traumatic events of 2020, it’s hard to think about there being a possibility that things could be better than forecast, but it’s certainly an option.

Now, with economic conditions improving, we are likely to see some modest inflation and a steepening of the yield curve along the midrange to the longer end. Looking at the Fed’s five-year, five-year forward rate, a key measure of future inflation, we can see this steepening.

In addition, RSM’s projection for the closely watched 10-year Treasury yield, which bottomed out in August at 0.51%, shows the rate approaching 1.3% by the end of 2021. Already, in the early days of the new year, the yield pushed past 1%.

Along with the rising rates, improving economic conditions will lead to a positive impact on loan portfolios as banks return to normal lending—not stimulus lending—and see the benefits of a strong growth cycle easing credit concerns. This, in turn, will lead to fewer credit losses.

Rising rates, new lending and fewer credit losses are enough to spur optimism in any banker.

The takeaway

While 2020 was characterized by stimulus funding, low interest rates and credit concerns, 2021 will most likely see a recovery and a revival of the U.S. economy. Banks will be positioned to capitalize on the momentum and help drive economic growth while also seeing the benefit to their financials