Research — Oct. 05, 2025
Banks face credit slippage but not as bad as some fear
By Nathan Stovall and Zain Tariq
Banks' net interest margins continue to improve and support strong returns, but the expansion has been overshadowed by investors' concerns over potential slippage in credit quality.
US bank earnings have continued to grow, buoyed by margin expansion and benign credit quality, save for a few, notable losses that emerged in the third quarter. Favorable results should continue through the end of 2025 as the consumer and the economy have remained resilient. Banks should be supported by additional margin expansion in 2026 as additional rate cuts by the Federal Reserve allow for greater relief in funding costs, but credit quality is expected to slip and serve as a greater headwind to earnings. Against that backdrop and a friendlier regulatory environment, bank M&A should continue to rebound as acquirers see deals as an attractive and faster way to gain scale — in the overall size of the company or specific markets — that they see as necessary to effectively compete.
Credit quality back in focus
While credit quality remains benign for most banks, investors were concerned about the potential for deterioration heading into third-quarter earnings season. The early reporters of third-quarter earnings show that credit quality remains benign and often improved.
Investors, however, focused on the emergence of a few sizable credit issues related to nondepository financial institutions (NDFI) that filed for bankruptcy or were accused of fraud. Western Alliance Bancorp. and Zions Bancorp. NA were among the banks disclosing losses related to allegedly fraudulent relationships and saw their stocks come under considerable pressure on Thursday, Oct. 16. The regional bank group also came under fire in the aftermath of those disclosures and comments earlier in the week from JPMorgan Chase & Co. CEO Jamie Dimon about the potential for more credit issues. Dimon warned that might be some excess in the system due to a long-term bull market for credit and noted that, "When you see one cockroach, there are probably more."
Still, many other bankers downplayed the concerns over the industry's credit quality and pointed to continued strength in the US consumer. Huntington Bancshares Inc. President and CEO Stephen Steinour was in that camp and said he expects the credit blips were "isolated issues" and noted that he is not seeing "forward indicators in terms of delinquency or other measures."
While many banks might not have sizable consumer or credit card portfolios, the consumer drives the economy. Consumer delinquencies have risen from historical lows, but early reporters of third-quarter earnings continued to show signs of trends stabilizing or normalizing, not deteriorating considerably.
The US consumer is stretched — savings rates have slowed, and excess savings accumulated during the pandemic have been exhausted — and recent slowness in the labor market could weigh on consumers. But, consumer balance sheets remain in relatively strong shape, with household debt to income tracking near long-term averages. Many borrowers took advantage of historically low rates to refinance their mortgages before the Fed began raising rates, reducing the impact that rate hikes would have on their debt service. Consumers and other borrowers are also expected to receive more relief in the form of additional rate cuts.
Banks face potential loss content in their other loan portfolios, particularly their commercial real estate portfolios, which faced intense regulatory and investor scrutiny in 2023 and 2024. Banks have reduced their exposure to CRE and have arguably benefited from private credit firms growing their market share and helping support the asset class. However, the industry is not completely out of the woods and will face higher loss content in the future.
We expect net charge-offs to rise significantly in 2026, but expect losses and the reserves required to fund them should serve as a modest headwind to earnings rather than a severe downturn.
We expect provisions to hold fairly steady at 20.8% of net revenue in 2025, compared to 21.1% in 2024 and 20.9% in 2023. On average, from 2013 to 2019, banks' provisions equated to 14.6% of net revenue. As credit quality slips in 2026, provisions should jump to 24.0% of net revenue.
Remixing of balance sheets drives margins higher
Banks continue to benefit from the remixing of their balance sheets as funding costs improve modestly, while lower-yielding assets purchased or originated when rates were low, mature and are reinvested at higher yields.
Deposit costs dropped substantially in the fourth quarter of 2024 and the first quarter of 2025, with the cost of deposits falling 20 basis points and 21 basis points, respectively, from the previous quarter. The pace of decline was much smaller in the second quarter, dipping just 2 basis points quarter over quarter.
Deposit costs are expected to hold fairly steady in the third quarter and third-quarter results from JPMorgan, Bank of America Corp. and Wells Fargo & Co. support that thesis. In the third quarter, JPMorgan's cost of interest-bearing deposits rose 1 basis points from the prior quarter and BofA reported a 2-basis point linked-quarter increase. Meanwhile, Wells Fargo's deposit costs in the third quarter were flat with the prior period.
A key driver of deposit costs has been the maturity schedule of certificates of deposits (CDs). Banks, particularly regional and community banks, increased their reliance on CDs for funding during the Fed's tightening cycle. CD pricing appears to have peaked in the second quarter of 2024 before the Fed's first rate cut in September. Since many CDs carry one-year terms, many institutions have already experienced relief from their highest cost CDs that likely matured in the first half of 2025.
At the end of the second quarter, the bulk of CDs were set to mature in the next year, with 39.3% of all CDs maturing or repricing in the next three months, while 86.7% of CDs were set to mature in the next 12 months.
When those CDs mature, most banks will have to meet market rates to retain the deposits. CD rates began declining in the third quarter of 2025, with far fewer institutions offering the products at rates over 4%. However, until the last few weeks, there was less movement around the 3.5% level.
The number of banks marketing one-year, $10,000 CDs over 3.5% included 947 institutions as of Oct. 10, down from 988 at Sept. 26, 1,050 as of Aug. 22, and 1,048 as of June 27.
The shedding of higher-cost CDs has helped banks lower their deposit costs, but banks will need to remain competitive with alternatives in the Treasury and money markets as they seek to cut costs further. The difference between the average fed funds rate and the industry's cost of deposits held steady in the second quarter of 2025. That gap should narrow as additional rate cuts by the Fed allow banks to lower their deposit costs while staying competitive with higher-yielding alternatives to maintain deposit growth.
Weaker loan growth should also reduce banks' funding needs and let institutions move deposit costs incrementally lower. Deposits should grow further, but interest-bearing deposits will continue to grow at a quicker clip during the remainder of 2025 than non-interest-bearing deposits — banks' most prized source of funding.
Loan yields have held up among early reporters of third-quarter results. Loan growth has remained positive as well but could weaken as borrowers digest new trade policies that could change the cost of operating their businesses and households. Weakness in the labor market and a few credit blips could also lead to greater caution among lenders and their borrowers.
Looking ahead
The desire to grow earnings, potential for higher credit losses, relatively slow loan growth and friendlier regulatory environment should support stronger bank M&A activity.
Bank M&A activity accelerated at the end of the third quarter and opened the fourth quarter with a bang when Fifth Third Bancorp announced plans to acquire Comerica Inc. The deal marked just the fourth bank deal over $10 billion in value since the financial crisis.
The Fifth Third/Comerica also represented the third quarter transaction involving a buyer with more than $100 billion in assets announced this year, following Huntington's purchase of Veritex and PNC Financial Services Group Inc. plans to buy FirstBank Holding Co. Large buyers and serial acquirers have returned as regulators have signaled that they are far more supportive of M&A activity. More buyers, the desire to gain scale, succession issues and stable fundamental trends should all lead to greater bank M&A activity.
The expected pickup in deal activity among regional and community banks would alter the competitive landscape. Buyers that gain scale through deals likely would be less focused on organic growth while integrating their acquisitions. They also will be more likely to address any concerns they have in their loan portfolios since bank M&A accounting requires the buyer to mark a target's balance sheet to market. The fair value mark would in theory allow an institution to purge unwarranted assets without taking large additional losses.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.