KBRA Financial Intelligence

Bank Lending Impacted by Rising Yields and Booming U.S. Deficit

More Gradual Fed Easing Contributes to Yield Curve Steepening

In January, the 10-year U.S. Treasury yield climbed to 4.8%, its highest level in over a year. This ramping up of long-term rates has defied several Fed rate cuts, rapidly reversing a multiyear yield curve inversion. Though reductions to the Fed’s benchmark overnight rate tend to drag on rates all throughout the curve, medium- and longer-term rates have remained persistently elevated due to several factors, including a reevaluation of how aggressively the Fed will continue cutting rates, as well as widening federal deficits, and the need to roll over a glut of T-bills.

This shift in long-term yields carries significant implications for banks, whose profitability, as measured by net interest margin (NIM), depends largely on their ability to fund long-term lending through deposits acquired at short-term rates. If further Fed cuts cannot start pulling down long-term rates, the yield curve could continue to steepen quickly, a positive development for banks if economic growth remains intact and borrowers continue to remain creditworthy.

Federal Open Market Committee (FOMC) members shocked many market participants by cutting the benchmark fed funds rate by 50 basis points (bps) on September 17, larger than the typical 25 bps increments the Fed has most often utilized to adjust rates throughout the last decade. The Fed also laid out a path toward 50 bps of further cuts through the end of the year as a median expectation in its dot plot, which it fulfilled by reducing rates in November and December. However, the shift in the Fed’s projections for 2025 have signaled that easing will be more gradual going forward.

Instead of the 100 bps of rate cuts projected last September, policymakers’ December dot plot suggested that 75 bps would be more likely. Fed funds futures traders have adopted a more hawkish stance since then. Following January’s FOMC meeting, when the committee voted unanimously to pause rate cuts, CME’s FedWatch tool showed that traders were pricing in a three-quarters probability of the Fed cutting by 50 bps or less in 2025.

U.S. Treasury Faces Difficult Refinancing as Deficit Widens

Bond market speculators had previously begun to front-run a more expedient easing of monetary policy, but the repricing of persistent inflationary pressures has caused long-term rates to reverse course. KFI previously flagged the ballooning U.S. deficit as a signal that long-term rates could stay elevated in November 2024, as risk factors associated with holding U.S. Treasury debt were becoming more prominent.

The U.S. fiscal 2024 deficit expanded to $1.8 trillion, marking the third-largest annual shortfall in history and an 8.1% year-over-year (YoY) increase. The deficit is being supercharged by expenditures on mounting interest payments, which recently jumped to a record high north of $1.1 trillion. With the Congressional Budget Office’s (CBO) latest projections showing the deficit increasing to $1.9 trillion in fiscal 2025, and rates likely to remain elevated, interest expenditures are expected to remain burdensome. Additionally, the U.S. could be on the hook for a large chunk of that interest for a longer period.

As of year-end 2024, T-bills—Treasury securities with maturities of one year or less—constituted nearly $6.2 trillion of outstanding U.S. marketable debt. That represents nearly 22% of the total marketable debt, exceeding a target range of 15% to 20% previously laid out by the Treasury Borrowing Advisory Committee (TBAC). The committee—which is made up of senior representatives from a variety of buy- and sell-side institutions, such as banks, broker-dealers, asset managers, hedge funds, and insurance companies—provides the Treasury with recommendations on a variety of technical debt management issues. TBAC has previously said that T-bills’ share of marketable debt could move “modestly” above 20% while still maintaining “financing flexibility” for the Treasury, but recent trends in issuance suggest that bills’ share of the debt is likely to expand even further in the near term.

The Treasury expects to borrow a total of $823 billion in privately-held net marketable debt in 1Q 2025, up significantly from $546 billion in the prior quarter. January data indicates that more than 85% of its marketable debt issuance in this quarter has been composed of T-bills, up from roughly 82% in the prior quarter. The share of T-bill issuance tends to rise in the early portion of an economic downturn, in anticipation that the Treasury will need to immediately raise capital for government spending measures to counter recession. The Treasury can then refinance these debts over a longer time frame in the future once interest rates fall. However, this more recent deluge of bill issuance has occurred during a period of robust expansion in the U.S. economy, and was meant to shoulder the weight of burgeoning deficits until the debt could be rolled over at lower rates once these begun to ease. Despite Fed rate cuts, long-term yields have not declined. Instead, they have moved higher since the Fed began easing policy in September 2024.

It appears increasingly likely that trillions of dollars of U.S. debt maturing throughout 2025 will need to be refinanced at persistently elevated rates. Continually rolling over debt at short-term maturities while maintaining elevated levels of bill issuance could expand T-bills’ share of marketable debt even further beyond what TBAC considers to be the target range. At the same time, if medium- and long-term rates do not fall significantly, financing the debt at longer maturities will leave the U.S. on the hook for expensive coupon payments over a period of several years, or even decades. Expensive obligations that are expanding at a faster rate than government receipts could give market participants pause when considering exposure to long-term U.S. debt.

If the Treasury does begin shifting its financing of U.S. debt further down the yield curve, a strong flow of new supply into Treasury notes and bond markets might continue to suppress prices, thereby buoying yields. Other variables that are likely to play a role in the fluctuations of long-term rates include increasingly frequent and contentious debt ceiling negotiations and newly confirmed Trump administration nominee Scott Bessent taking over the office of Secretary at the Treasury Department.

Impact on Bank Lending and Margins

As KFI noted in December, recent trends in banks’ debt issuance suggest that many financial institutions expect higher long-term rates in 2025. If this plays out, the ongoing yield curve steepening could continue, generally benefiting lending conditions. Though average rates on several lending products saw a pullback in mid-2024, resurgent yields on Treasury notes and bonds should bring those rates back up, as seen with mortgage rates, which soared back to a seven-month high north of 7% in January. The resurgence appears to have slowed momentum in mortgage lending, as 3Q 2024 data showed that the total mortgage value held by U.S. banks increased by just 1.9% YoY (equivalent to approximately $53.9 billion). That marked the second-smallest annual increase over the past two years, with net mortgage growth lagging behind total loan volume growth for the first time in seven quarters.

While elevated long-term rates may constrain credit growth, a steeper yield curve could alleviate pressure on banks facing compressed NIMs. Many banks were forced to undertake aggressive cost-cutting measures to maintain their margins over the past several years, which resulted in the fastest pace of commercial bank job cuts since 2009 last year. Individual banks and credit unions can be sorted by NIM, as well as loan composition, the delinquency rate impacting those loans, and a variety of other financial metrics via the Data Wizard in KFI’s Excel add-in. To access our full library of data, including KFI scores for nearly 10,000 banks and credit unions, request a demo with KFI today.

Recent M&A

Several notable mergers and acquisitions (M&A) transactions have been announced in early 2025, reflecting ongoing consolidation trends in the banking sector.

Reading, Massachusetts-based Reading Co-operative Bank (KFI Score: B) announced in a January 2 press release that the $922 million bank will merge with $313 million Wakefield, Massachusetts-based Wakefield Co-operative Bank (KFI Score: B) for an undisclosed price. The deal is expected to close in 2Q 2025.

Corsicana, Texas-based Community Bank Holdings of Texas, Inc., the parent company of $1.3 billion Community National Bank & Trust of Texas (KFI Score: B+), announced in a January 7 press release that it will acquire $344 million CapTex Bank (KFI Score: B), the bank subsidiary of Fort Worth, Texas-based CapTex Bancshares, Inc., for an undisclosed price. The deal is expected to close in 2Q 2025.

Clearfield, Pennsylvania-based CNB Financial Corporation (NASDAQ: CCNE) (KFI Score: B+) announced in a January 10 press release that the $6 billion lender will buy $2.2 billion Stroudsburg, Pennsylvania-based ESSA Bank & Trust (KFI Score: B) and its parent company, ESSA Bancorp (NASDAQ: ESSA), in an all-stock transaction valued at $214 million or approximately $21.10 per ESSA share. The deal is expected to close in 3Q 2025.

Kalispell, Montana-based Glacier Bancorp, Inc. (NYSE: GBCI) (KFI Score: B), the parent company of $28.2 billion Glacier Bank (KFI Score: B), announced in a January 13 press release that it will acquire $1.3 billion Bank of Idaho (KFI Score: B), the bank subsidiary of Idaho Falls-based Bank of Idaho Holdings, Co. (OTCQX: BOID), for $245.4 million or approximately $52.47 per BOID share. The deal is expected to close in 2Q 2025.

Gulfport, Mississippi-based Hancock Whitney Corporation (NASDAQ: HWC) (KFI Score: B+), the parent company of $35.2 billion Hancock Whitney Bank (KFI Score: B-), announced in a January 21 press release that it will acquire the Saint Petersburg, Florida-based non-depository trust company Sabal Trust Company for an undisclosed price. The deal is expected to close in 2Q 2025.

Oceanside, California-based Frontwave Credit Union (KFI Score: B) announced in a January 22 press release that the $1.5 billion credit union will acquire $311 million Community Valley Bank (KFI Score: B) based in El Centro, California, for an undisclosed price. The deal is expected to close in 2H 2025.

Tupelo, Mississippi-based Cadence Bank (NYSE: CADE) (KFI Score: B) announced in a January 22 press release that the $47 billion lender will acquire Savannah, Georgia-based FCB Financial Corp., the bank holding company of $589 million First Chatham Bank, for $103.6 million. Under the terms of the merger agreement, Cadence Bank will issue 2,300,000 shares of common stock, plus $23.1 million in cash, for all outstanding shares of FCB Financial Corp. stock. The deal is expected to close in 3Q 2025.

Reno, Nevada-based Plumas Bancorp (NASDAQ: PLBC), the parent company of $1.6 billion Plumas Bank (KFI Score: B+), announced in a January 29 press release that it will acquire Red Bluff, California-based Cornerstone Community Bancorp (OTCPK: CRSB), the bank holding company of $669 million Cornerstone Community Bank (KFI Score: B) in a stock and cash transaction valued at $64.6 million. The deal is expected to close in 2H 2025.

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