KBRA Financial Intelligence

Trump Tariffs May Expand Bank Margins, but Weaken Construction Lending

Tariff Threats Ignite Uncertainty in Monetary Policy

In late January, President Trump announced a 25% tariff on imports from Mexico and Canada, alongside a 10% increase on imports from China. Although the new tariff regime on all imports from these countries was short-lived—following agreements between the two North American nations and the U.S. on new border control measures that will suspend duties on their goods for one month—Trump signed an order Monday to enact targeted tariffs on metal products imported into the U.S. Though many global exporters will experience the impact of these new duties, Mexican and Canadian enterprises will still feel them more harshly than those in most other nations.

Although Mexico and Canada have considered retaliatory tariffs, sustaining a trade conflict with the U.S. poses significant challenges for these economies. According to World Bank data, over 75% of their exports are destined for the U.S., whereas less than one-fifth of U.S. exports flow to these two countries. Policymakers at the Bank of Canada acknowledged the serious probability of “economic consequences” emanating from a protracted trade war during their January 29 meeting. The central bank was already amid a rate-cutting cycle, which may be accelerated to offset the anticipated slowdown in growth.

In the U.S., the impact of tariffs could eventually necessitate an opposite monetary policy response. Federal Reserve Chair Jerome Powell was more stoic than his Canadian counterparts when asked about tariffs during the most recent Federal Open Market Committee (FOMC) press conference, noting that inflation expectations are moving up “a little bit, at the short end, but not at the longer run, which is where it really matters.” Despite Powell’s long-term outlook, bond markets have reacted strongly to inflation stabilizing above the Fed’s 2% target. The annual change in the Fed’s preferred inflation gauge—the Core Personal Consumptions Expenditures (PCE) Price Index—shows inflation reaching a three-year low in June 2024. Since then, stiff price pressures and resilient employment figures have contributed to the rebound in long-term rates. As the cost of tariffs can be passed onto consumers in the form of price hikes on goods subject to duties, the threat of tariffs is likely contributing to expectations that inflation will be more difficult to tame than the Fed is currently assessing.

An upward shift in long-term yields, especially when moving against Fed cuts at the short end of the yield curve, carries significant implications for banks. Their profitability is commonly gauged by net interest margin (NIM), which is the difference between costs associated with maintaining their liabilities (i.e., deposits) and the yield on their lending assets. If additional Fed rate cuts do not have a dampening impact on long-term yields, the yield curve may steepen further. This scenario would benefit lenders, provided economic growth remains stable and borrower creditworthiness is maintained.

Custom Duties Unlikely to Dissolve Deficit Concerns

The Fed has adopted a more gradual approach toward easing compared to its initial rate-cutting strategy last year. This has caused yields on U.S. Treasury bonds to move higher, ending a drawn-out inversion in the yield curve. KBRA Financial Intelligence (KFI) noted in its January Insight report that the recent rise in medium- and long-term rates is also linked to widening deficits and other variables driving up costs and uncertainty associated with the nation’s fiscal outlays. President Trump has proposed using tariff revenue as an alternative to income taxes for funding the federal government. Despite generating hundreds of billions of dollars since Trump previously broadened U.S. customs duties in 2017, tariff revenue remains a small portion of total expenditures and has not offset the rapid rise in government spending.

Annual growth in tax payments earned from customs duties surged to a more than four-decade high during Trump’s first term in the White House and the total revenue from tariffs continued breaking through all-time highs during the Biden administration. However, a stronger expansion of government spending has largely nullified these gains. Although tariff income is more than 62% higher than in 2018, it still covers only about 1.2% of current federal expenditures, leaving its overall share largely unchanged.

Nonpartisan think tank Tax Foundation recently estimated that 25% tariffs on Canada and Mexico and 10% tariffs on China would increase federal tax revenue by $1.1 trillion between 2025 and 2034 on a conventional basis. That is a significant figure, but it does little to address the $22.1 trillion in cumulative deficits that the Congressional Budget Office (CBO) has projected the U.S. to rack up over the same period. Although Trump has temporarily backed off from his specific trade war threats against Canada and Mexico, the new duties on Chinese goods remain in place.

Treasury Secretary Scott Bessent has previously stated that tariffs could be a “revenue raiser for the federal budget,” but has more recently claimed that there are several aspects to the Trump administration’s tariff strategy and this first round of duties is “not a revenue issue right now.” If tariffs are increasingly used as a fiscal tool, broader and more stringent measures may be required. President Trump has previously proposed levying general tariffs on all U.S. imports, ranging from 10%–20%, and a massive 60% tariff on Chinese products.

Construction and Development Lending Exposed to Trade War

Construction and development (C&D) lending is particularly vulnerable to trade tensions and is already experiencing notable weakness. Price pressures that are squeezing construction firms and their buyers could be heightened by new 25% tariffs on all steel and aluminum imported into the U.S. A quarter of steel used in the U.S. is imported, according to data recently compiled by Reuters, with Canada and Mexico serving as the first- and third-largest suppliers of foreign steel product to the U.S. When it comes to aluminum, roughly half of the supply utilized in the U.S. is imported and the vast majority of foreign product originates in Canada.

The three nations who may still face additional U.S. tariffs in March are key suppliers of various construction materials and components to the U.S. According to OEC international trade data reviewed by KFI, upward of $54.5 billion worth of Canadian exports related to iron, steel, nickel, aluminum, and copper products as well as wood, gypsum, piping, and construction vehicles, was shipped to the U.S. in 2022. The value of similar products arriving in the U.S. from Mexico and China was roughly $30.5 billion and $20.5 billion, respectively.

The most valuable category of export good among the three nations who could face additional tariffs in March was Canadian sawn wood, valued at nearly $9.3 billion, surpassing Canadian aluminum at $8.9 billion. Canada has long been the largest foreign supplier of softwood lumber to the U.S., accounting for 95% of imports throughout the past several decades. Canada’s softwood exports were slammed with a 14.5% tariff in 2021, and the imposition of additional 25% tariffs will bring those duties to 40% if a trade war is not averted. The National Association of Home Builders (NAHB) sent a letter to President Trump in late January, warning that tariffs impacting building materials from Canada and Mexico risks “slowing down the domestic residential construction industry.” The recent rise in long-term rates has already constrained housing affordability, with mortgage rates nearing 7%. A sharp increase in material costs could further elevate home prices, exacerbating the ongoing slowdown in mortgage lending, as highlighted by KFI.

KFI data from Federal Financial Institutions Examination Council (FFIEC) call reports indicates that U.S. commercial banks have experienced a year-over-year decline in loans secured by one- to four-family residential construction projects for six consecutive quarters. After a prolonged softening of growth, other construction and land development loans also receded alongside residential construction lending. The drop in this category marked the first in 11 years. Delinquency rates impacting commercial banks’ C&D loans increased to 1.44% in 4Q 2024, the highest level since 2020. KFI highlighted a number of U.S. banks maintaining above-average concentrations of C&D lending in December. Individual banks and credit unions can be sorted by loan categories and the delinquency rate impacting those loans via the Data Wizard in KFI’s Excel add-in, as well as the Loan Category and Delinquency Report template from our Template Library. To access our full library of tables and templates, request a demo with KFI.