skyscrapers in Manhattan at sunset, New York City

The U.S. banks managed solid first-quarter results, as strong fee income and cost control combined to offset continued pressure on net interest income, according to a new report from Morningstar DBRS.

The rating agency said the banking sector produced a good first quarter despite a “more challenging” operating environment. 

In the first quarter, net interest margins came under increased pressure, the report said, adding that loan growth was weak too, particularly for commercial lending, “primarily due to lower demand, as well as the reopening of capital markets.”

However, the revival in capital markets activity produced strong revenues that helped offset this weakness in lending. And trading performance picked up alongside the rebound in investment banking, it noted. 

Debt issuance surged in the first quarter, with investment grade new issue activity reaching near-record levels, the report said, along with a pickup in merger and acquisition activity, high-yield debt issuance and syndicated loan activity.

Looking ahead, the report indicated that net interest income is expected to start growing once again in the second half of the year.

“We still expect modest total loan growth in 2024, presuming there is greater clarity around the path of interest rates and regulatory capital requirements,” it said. 

Turmoil in commercial real estate also intensified in the first quarter, “as several banks reported higher losses from this exposure,” the report said. 

In the coming months, DBRS said it expects “troubles in [commercial real estate] to weigh on results, but this process will likely take multiple years with losses spread out, as banks work through maturing loans.”

However, it cautioned that if interest rates stay at elevated levels for longer, this may lead to deteriorating credit conditions in some portfolios.

Nevertheless, given the strength in banks’ capital positions, their high loan-loss reserves and strong earnings power, DBRS said it expects “any fallout to be manageable at banks within our coverage universe.” 

The banks’ capital ratios are generally stable too, with banks anticipating that regulators will be increasing their capital requirements in the near future.

DBRS said it views even the current proposals for tougher capital requirements to be “manageable”  for the banks, but it also expects regulators to modify those proposals in an industry-friendly way before finalizing the rules.