U.S. banks are expected to report lower sequential net interest margins (NIM) during the second-quarter 2019 earnings season as the Treasury yield curve has notably flattened, according to the latest dashboard report from Fitch Ratings. The Federal Reserve's more dovish tone and Fitch's expectation that the Fed will not raise rates for the rest of 2019 will likely be a setback for banks margins.

Yields on earning assets such as loans and investments, which typically price off longer parts of the curve, have continued to fall, while funding costs, which typically price off the shorter end of the curve, have remained steady for the most part.

"Lower long-term rates combined with still strong competition from non-bank lenders for loans should produce tighter margins," said Bain Rumohr, Senior Director, Fitch Ratings.

If the Fed reduces its target in the second half of 2019, banks with lower loan demand may be able to reduce deposit rates, especially as deposit betas had begun to increase fairly notably toward the end of this past rate tightening. This would be a potential scenario where banks could see margins grow if longer-term rates stay fairly stable and the curve steepens even modestly. However, Fitch believes those banks that already have high loan-to-deposit ratios and were quick to raise rates during the tightening cycle, will likely not be able to reduce funding costs as quickly, especially if they are expecting faster-than-peer loan growth. Therefore, we would not expect these banks to show margin expansion in the near-term.

If and when margins fall and net interest income growth stalls, Fitch does not expect any material impact to ratings as a NIM expansion had already been expected to taper off.

"If interest rates do fall further, banks that continue to adequately manage inherent interest rate risks should see few, if any, credit rating changes," added Rumohr.