Though the nation's banks face financial stress if the nation goes over the fiscal cliff, at least one arbiter of creditworthiness says their capital could cushion the blow.
Banks have the wherewithal to weather a drop in earnings that a recession sparked by the plunge could produce, Moody's wrote in an analysis published Monday.
The ratings agency observed that the ratio of banks' equity to risk-weighted assets stood at 11.2% in the third quarter of 2012, compared with roughly 5% in the same period three years earlier when chargeoffs began to rise significantly.
"The banks have a much stronger capital position today than they did entering the [financial] crisis," Joseph Pucella, a senior analyst at Moody's who co-wrote the analysis, told American Banker. "In addition, they have cleaner balance sheets, so despite higher credit costs that would come about through a recession, as well as pressure on profitability, we think for the most part the banks have the capital to absorb the hit."
The analysis by Moody's comes amid a push by lawmakers for a pact that would avert more than $500 billion in tax increase and spending cuts slated to take effect Jan. 1. Under those conditions, gross domestic product would fall by 0.5% in 2013 while unemployment would climb to 9.1%, according to an analysis in November by the Congressional Budget Office.
Still, while many banks have sufficient capital, a cliff-induced recession would most certainly hurt profits.
An uptick in unemployment would weigh on home sales and cause real estate values to tumble, which could undo a trend that has seen the number of troubled loans held by banks fall over the past three years, according to Moody's.
"With a recession, we assume the Federal Reserve would keep interest rates low," said Sean Jones, an associate managing director at Moody's and Pucella's co-author. "That's constructive on a macroeconomic basis but it would mean the banks' net interest margin would continue to fall, hurting profitability."
A drop in real estate values also would threaten a boom in refinancing home loans that has eased the profit pressure caused by low interest rates, Jones added.
"With the so-called fiscal cliff looming, we are awaiting signs of a quick compromise to prevent a tax hike for most Americans next year," Christopher Martin, chief executive of Provident Financial Services (PFS) of New Jersey, wrote in a forecast published Monday. "When combined with persistent unemployment and increased healthcare costs, these events will impact the banking industry and overall pace of the economic recovery next year.
Some bankers say the uncertainty has spurred them to take steps to prepare for fiscal Armageddon. McCall Wilson, the president and chief executive at the $309 million-asset Bank of Fayette County in Moscow, Tenn., says he is planning to stock branches with additional cash because he is concerned that some panicked customers will yank out their deposits.
"My concern [about going over the cliff] is not the spending cuts or the tax increases, but rather what it's going to do to the psyche of Americans," Wilson says. "It's the fear of the unknown.
Alan Kline contributed to this story.