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End of Easy Bank Profits? Not a Chance!
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Submitted by Leo Kolivakis, publisher of Pension Pulse.
The NYT reports that Fed Move May Signal End to Easy Bank Profits:
Federal
reserve to Wall Street: The days of easy money — and, just maybe, easy
profits — are numbered, Graham Bowley and Eric Dash report in The New
York Times.
News on Thursday that the
Fed would raise the interest rate that it charges banks for temporary
loans was seen by lenders as a sign that their long, profitable period
of ultralow rates was coming to an end.
The move suggested that
policy makers believed the nation’s banks had healed enough to withdraw
some of the extraordinary support that Washington put in place during
the financial crisis. And, while all
those bailouts stabilized the banking industry, it was low rates from
the Fed that helped propel banks’ rapid recovery.
Even though
the Fed had telegraphed its intention to raise the largely symbolic
discount rate, the timing of the move, coming between scheduled policy
meetings, caught some economists by surprise. Stocks and bonds sank in
after-hours trading, suggesting Friday could be an anxious day for the
markets.
“This is a victory lap by the Fed,” Zach Pandl, economist at Nomura
Securities, said. “It is a signal that the Fed is very confident in the
health of the banking system. Fundamentally, these actions are a sign
of policy success.”
Since the crisis,
the Fed has nursed banks back to health with extraordinarily low rates.
Banks have been able to borrow money cheaply and put it to work in
lucrative ways, whether using the money to make loans at higher rates
or to trade in the markets.
The difference between short- and
long-term interest rates is near a record high, presenting a profitable
opportunity for banks. The difference between two- and 10-year Treasury
rates, for instance, is about 2.9 percentage points. Buoyed by such
policies, banks’ profits — and banking stocks — have rocketed over the
last year.
Many economists said banks were no longer borrowing
in large amounts from the Fed using the discount rate, and so the move
on Thursday was, in a sense, purely technical.But it was a sign
that the threat of a collapse in financial markets — so real just a
year and a half ago — had dissipated. Some economists said that, with
unemployment high and the economy growing slowly, the Fed would not be
raising the more important benchmark interest rates for some time.
“This
does not say anything about interest rates, but it does say something
about what has happened on the ground, that the financial industry is
not under same stress as it was previously,” Frederic S. Mishkin, a
professor at Columbia and a former member of the Fed’s board of
governors, said.
Others countered that the move at least brought
forward the moment when interest rates would begin to rise again — and
put an end to the banks’ period of easy money.Louis V.
Crandall, chief economist at Wrightson ICAP, said it demonstrated “a
willingness to entertain an early start to the real business of
retreating from the Fed’s very accommodating stance.”
Unnerved
by this prospect, at least in the short term, the bond market fell
after the Fed’s announcement, driving up the yield on 10-year Treasury
notes about seven basis points, or seven-hundredths of a percentage
point, to 3.8 percent.
Stock futures also fell in after-hours trading. Financial shares were particularly hard hit, with shares of big banks like JPMorgan Chase and Bank of America each falling about 1 percent.
The uncertainty over what the Fed will do next, and when, is a big worry for bankers.
“It
creates real havoc in managing a bank when you have to ride through
these cycles when interest rates change rapidly,” said Douglas J.
Leech, the chairman and chief executive of Centra Bank, in Morgantown, W.Va.Many banks are still coping with bad mortgages and other loans. “This poses a new threat,” Mr. Leech said.
Rising
interest rates will invariably squeeze banks’ profit margins and reduce
the value of some lenders’ own investments. Taken together, those
developments will hurt banks’ bottom lines, a particular worry for the
many small and midsize banks that are struggling to cope with the weak
economy.
Many banks have tried to prepare for an inevitable rise
in rates by locking up customers’ deposits, which provide a stable
source of funding for loans. Centra, for instance, began extending the
term of its certificates of deposits to 16 months, from 12 months, last
year. The bank also began offering low-rate loans that it can reset at
higher rates in 18 months, in case, as Mr. Leech expects, interest
rates rise.
The stock market dipped Friday morning and then climbed back up to close marginally in the green. It was another option expiration blowout.
Does the Fed's move signal hard times ahead for banks? Absolutely not. As I mentioned yesterday, the U.S. recovery is not just fluff and policy remains highly accommodating. Jon Najarian was on Tech Ticker on Friday saying that the money machine is still hot:
Given
the rate hike came on the eve of options expiration and after a 3%
rally in the S&P 500, Najarian says the upside bias Friday is
notably bullish. That's even more so given the bears have been saying
the market would tumble at the first signs of the Fed starting to slow
the easy money gravy train.
"The bears have got the bad news that they want and they haven't been able to drive" the market down, he says.
Similarly, Najarian says the conventional wisdom that the Fed's action is negative for the banks
is overstated, and misses a crucial fact: The yield curve remains very
steep, meaning the difference between short- and long-term rates is
very wide. As long as that's the case, banks have a "money machine" at
their disposal, he says. "I don't see dramatic downside action in the
financials [and] I'm not looking for that."
Najarian is
long Goldman, Wells Fargo, US Bancorp and JP Morgan, albeit with hedges
as he's expecting the group to remain range-bound for the time being.The
trader and CNBC contributor has the same outlook for the market as a
whole, barring an upside surprise on jobs or a negative shock from
Iran; Mahmoud Ahmadinejad is a bigger "wild card" for investors right
now than Ben Bernanke, he says.
Earlier this week, Martin Roberge, Portfolio Strategist & Quantitative Analyst at Dundee Capital Markets wrote that the M&A revival has begun!:
Non-financial Yesterday in the As we reported in At the sector level, Bottom line: Yesterday’s The
companies have built enormous cash balances over the last few years
owing to global economic uncertainties freezing corporate spending
activities. With the confidence of corporate CEOs now recovering, the
size of recent M&A transactions suggests that this hoard of cash is
ready to be redeployed, which should act as a support for broad equity
markets over the balance of the year.
fertilizer sector, Terra Industries agreed to a friendly takeover by
competitor Yara for a $4.3B all-cash bid. Also, Simon Group Properties
(a shopping-mall operator) made a $10B offer to acquire General Growth
Properties, including $9B in cash. Obviously, these sizable “cash”
transactions have sparked an M&A revival that is likely to continue
for the balance of the year with the most recent reading in US CEOs
confidence (64) returning to a 5-year high.
our Winter 2010 Strategy Report earlier this year, global non financial
companies generated a record $3.6 billion in free cash flows (FCF) in
2009 (Chart above, 1st panel). As a percentage of enterprise value
(EV), the FCF yield for global non-financial companies increased from
8.2% in 2007 to 10.3% in 2009. A high FCF yield not only means excess
cash on companies’ balance sheets that could be used to 1) buy back
stocks or 2) increase dividends, but 3) it provides fundamental value
for potential acquirers. Interestingly, Canada represents a land of
opportunity as the 11.7% FCF yield of the S&P/TSX non-financial
index is the highest among G7 countries.
the biggest FCF generators and FCF yielders are energy, industrials,
consumer discretionary and telecom (Chart, 2nd and 3rd panels above).
While telecoms (15.6% FCF yield) offer few M&A opportunities, it is
the best positioned to increase dividends among all sectors which is
why it is our favourite defensive play. As for energy and industrials,
M&A transactions are likely to take centre stage as these two
industries remain highly fragmented still.
sizable cash takeover offers sparked a much awaited M&A revival.
With non-financial companies sitting on enormous cash balances and CEO
confidence building higher, expect more M&A transactions in 2010,
likely to involve bidding wars and “white nights”. Finally, share
buybacks and/or dividend increases should become more frequent. These
are all supportive factors arguing against a renewed equity bear market.
M&A revival will bring additional fees to big banks, adding to their
bottom line. So don't shed a tear for banks; the money machine is still
hot and banks will continue printing profits as the Fed raises the
discount rate and will continue even after the Fed raises the key Fed
funds rate.
Very
few people know that it was under the Clinton administration that
deregulation of OTC derivatives really took off. Years of speculative
activity led to the last financial crisis. I quote:
"We
didn't truly know the dangers of the market, because it was a dark
market," says Brooksley Born, the head of an obscure federal regulatory
agency -- the Commodity Futures Trading Commission [CFTC] -- who not
only warned of the potential for economic meltdown in the late 1990s,
but also tried to convince the country's key economic powerbrokers to
take actions that could have helped avert the crisis. "They were
totally opposed to it," Born says. "That puzzled me. What was it that
was in this market that had to be hidden?"
We now
know what was in the market that had to be hidden. Financial garbage
with AAA ratings. After watching that episode, I came away admiring
Brooksley Born for her principled stance and her dire warning at the
end of the episode is absolutely correct. As long as we allow banks to
continue printing profits by taking stupid risks, the next financial
crisis is only a matter of time.
»
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If you need a good laugh (or cry), check out Citigroup’s new money-making scheme:
http://www.marketwatch.com/story/citigroups-new-plan-profit-from-the-nex...
When I take a look at the financials of a major bank such as WFC, I have to agree with Leo. Look at WFC's additions to loan loss reserves. Things must really be picking up in dramatic fashion in California if WFC feels they no longer have to add so much for potential losses, but the MSM is just so full of Cassandras that we never hear how home prices are skyrocketing.
Also, we must realize that the very nature of banking has changed. Gone are the days when banks took in deposits and actually made loans. This type of activity is fraught with danger. No, the NEW world of banking is to post crap at the Fed window and use the money to ride the yield curve. The incremental costs in this new world of banking are zero, as who needs staff or branches or tellers or ATM's when all banks really need do is borrow from the government then loan the same money back to the government at a big fat spread. And the kicker is that banks can take a bit of that money and speculate on things the government tells them are going to go up in price.
Some wags will try to argue that there is an avalanche of Alt-A's and Option Arms that are going to present new problems for banks this year and next. Those eternally irritating Cassandras also try to scare the masses by claiming there is some problem with commercial office space or empty malls. What? Many of these same folks seem to think that oversupply of commercial and residential space in China is a positive because it is money spent on fixed assets that contribute to GDP, yet for some reason empty homes and offices and malls in the US is bad. That is just the kind of pessimistic and defeatist thinking that stands in the way of a new dawn and a robust recovery.
Furthermore, now that the accounting profession is on board and establishes rules and procedures based on optimism rather than pessimism, we are ready to move ahead with a strong wind at our backs. WE CAN MAKE IT HAPPEN. What do you WANT those assets to be worth? That's the key.
I am rich too, just dont have the money yet
dear Leo, i am big fun of yours and and almost always agree with you (except your stock picks and solar energy madness) but this article is just nonsense. Profits of banks is function of yield curve. Thats all. Nothing else nothing more. Steep curve - big profits. So, what is the point to write anything else about it?
What FED trying to do is to force banks to lend money. Did you see consumer credit picture http://macroblog.typepad.com/.a/6a00d8341c834f53ef012877819add970c-popup
And btw its NOT easy profits, its balance sheet repair mode - read R Koo...
Help me dig this hole and see how much profit we get out of it.
A shovel gives blisters and a pain in the back.
Didnt realize how to keystrokes add up.
Can you die from a paper cut?
hi cu Lol
Umm, let's get one thing straight, the Fed can't force banks to do anything, especially not lend to small and medium sized businesses. Big banks make profits from various activities, not just prop trading. It's not just about the yield curve. A close buddy of mine who works at large bank told me the banks want higher rates so they can charge more interest on lines of credit. They will use ay rate hike as an excuse to jack up spreads and fees.
dear Leo.
1. By jacking up Discount rate fed forcing banks to increase lending. Next step going to be charging negative interest on CA, so banks will be forced to go out and do something with this money.
2. Close buddy of yours must be working as janitor. Bcs he has NO IDEA how bank operate. Bank classical business model is: BORROW SHORT TO LEND LONG. this how they made money for pas 500yrs and when they start doing clever things they collapsed. Now what matters for bank borrowing cost vs lending.. not absolute level of rates. This btw why CDO and CDO SQUARE come in picture, bcs CURVE WAS FLAT. When rates are high - curve is flat, so banks borrow at 5% and lend at 5%. Where the money? It force banks to go and do other other stuff, that brings us to where we are now. So steep curve this whats matter, tell this to your buddy, may be one day he learns more about banking
LOL, my buddy knows more about banking then you, me and everyone else here. But thanks for the refresher course on borrowing short and lending long...lol! Get it through your head, the Fed is owned by the big banks (not directly, indirectly). Yeah banks are starting to lend again, but I suspect theyère not going to lend heavily and terms will not exceed three years. Importantly, this is not where the juicy margins will come from. M&A, prop trading, F/X and other ancillary business is where they're going to make their money.
sorry, i can not do this. I can't get it through my head. I don't believe in blue faced smurfs from Avatar, i don't believe in global jews plot to overthrow govt, i don't believe that Bush or Obama been controlled by alien UFO.. And last but not the least i don't believe in little lepricons who manipulate gold prices.
But i do believe in FED. IN FED WE TRUST! You can argue they created this mess (but i am not even sure they did, as i don't think it was LOW level of rates, it was flatness of the curve, driven by demand for long dated paper from Asia), And FED has no mechanism to control long rates (I can argue they should, but its different story). I think FED done a great job trying to prevent deflationary spiral. And i hope they win this battle. I been staying in Japan for many many years and I know what deflation is: its slow death and decay...
II also thing they doing right thing by normalizing disco rate, and I hope they start to charge negative rates on CA. It good for economy, and helps lending.
On another note, majority of profits for banks come from borrowing and lending... I mean BANKS not Investment Banks!
the data that shows improvment lol
We now officially live in a world where intentionally-incorrect data is published by our government for the specific intention of misleading the market ,, dennenger
Agree with you , Leo, that the unregulated OTC derivatives were super charged under the Clinton Administration. I believe it was CFMA 2000 that Clinton signed less than 60 days before he left the White House for good. It was slimed into passage by Phil Gramm and his wife Wendy, a former CFTC official. So it has GOP fingerprints all over it too.
I suspect Clinton made a lot of deals with the Devil to avoid conviction in the Senate on the impeachment business and the CFMA scheme was probably one of those back-scratching promises.
I'm no fan of W or either political party, but only the naive would pin the meltdown of 08 on just W and the GOP. Now the unregulated derivatives cancer is so spread into the international economic system, only an explosive collapse would begin to clean it out.
We live in an age of distorted valuation and corrupted accountability. The various schemes to deceive have been buiding for many years.
"We live in an age of distorted valuation and corrupted accountability. The various schemes to deceive have been buiding for many years."
Have you seen what public pension funds have been buying lately? This is an understatement...thx.
pretty much, if interest rates will go up by a large margin, the below illustration highlights what profits banks will be making:
http://www.youtube.com/watch?v=uV3Yua4KioQ&feature=player_embedded
LOL
p.s. Leo don't take the anger of some readers to close the heart , when it comes to jobs, it's a jungle out there for those who are looking.
Comrade,
Trust me I know it's hard out there. Take it from me, not only do I limp into interviews and get the usual stares of surprise/pity which I hate, but also have powerful pension fund managers who are working hard behind the scenes to blacklist me from every potential job in the financial services industry. They should be careful for what they wish for - I am far more dangerous when sitting at home analyzing their moves in detail. I can think of a few pension fund presidents who regret the day they fired me. This Greek-Canadian doesn't allow himself to get bullied by arrogant jerks who equate pension fund money with power. I got a lot more leverage now that I'm blogging and they know it.
Read why it is any legislation designed to put foreclosures on the fast-track would be bad for homeowners...
See:
My mortgage company is stealing my money -and my home! A new definition of home robbery?
http://tinyurl.com/yfmueel
Be sure to watch the video embedded in blog, and then scroll down to find another investigative report in the comment field.
You owe it to yourself to watch these videos -especially if you have a mortgage and believe that by simply making your payments on time, your home is safe from foreclosure--think again!
Investing in the common equity of most of the TBTF banks is the greatest ponzi scheme of our time. It's hysterical to watch the bank analysts (sell siders, natch) upgrade each other to the moon as they have over the past several months. yep, the same group that rarely hints that the equity markets will go down. the last 10 yrs of the SPX returns certainly prove that as well as a few years before that with the dot com bust ponzi scheme.
As to banks as a money machine, most of them are insolvent based on a mark to market basis and accounting deficiencies like these will eventually succumb to cash flow. The banking model in the USA has changed and will change even more over the next few years to the bank's detriment. M&A is but one income stream and that is a big "if" for now. A reintroduction of Glass Steagall types of reform will split traditional banking from investment banking and it WILL happen in the USA, just a question of when. Those that go the IB route (GS, MS, ML will swing out of that p.o.s. BAC etc) will likely do well in the future separated from traditional banks. The traditional banks in the USA will end up morphing into quasi public utilities.
USA bank capital levels are woefully inadequate and we are just as close to the abyss as we were circa Lehman (and Bear for that matter) days. The further frightening matter about this is that the US gov't, via the FDIC, has no money left to handle a potential next wave of bank closures. Hell, we have at least 600-800 (not including the blessed group of 19) to close in this country and FDIC can't even cover them, without a massive tap of the Treasury line of credit.
I can confidently say that I am better at bank valuation than many, and there is not one false statement in Deadhead's comment above. As a matter of fact, I feel that he grossly understates the issue of the overvaluation of the banks balance sheet assets, and understatement of their contingent liabilities.
Any signs of when this happens? Cash flows are the hardest of the financial statements to fake, my accounting professor would always say.
BS....as is always the case, timing is the most difficult thing to guess at.
In this case, we have the US regulatory complex doing everything they can to look the other way and in some cases actively encouraging the matter, such as the FDIC ridiculous 1.5 year capital waiver for FASB FAS 166/167 assets, also known as the Grand Cayman tsunami of fecal matter.
Certainly the increase in interest rates would accelerate the problem and interest rates will go up (i've never tried to predict rates but with fed funds at zero, it's a pretty safe guess for starters). How the social mood morphs over the next year will be huge....the social contract is breaking down somewhat, the American citizenry absolutely hates the banks, leading to the debtor's revolution tactics that are occurring, and the Feds are responding to the anti bank populism with strategies to tax them (absolutely stupid as the capital should stay with the banks as reserves but the stupid bankers in a complete abandonment of fiduciary responsibility, stuffed the profits in their pockets. yet another reason not to buy a single share of bank common because these guys don't give a shit about the bank owners).
This can can probably be kicked for a loooong time so it may be hard for cash flow matters to rule the day. Remember that the Fed is simply GIVING money to banks by buying their shit paper at par.
"The M&A revival will bring additional fees to banks, adding to their bottom line. So don't shed a tear for banks; the money machine is still hot and banks will continue printing profits as the Fed raises the discount rate and will continue even after the Fed raises the key Fed funds rate."
I disagree unless by banks you define only a few of former investment banks. For most of the money centers and regional banks the high (insane lately) spread between the cost of their money and the price (interest on) for loans is the only things that keeps them afloat. In addition let's not forget about none performing loans on the books of WFC, BOA, C and alike. The moment they have to pay 4% + on the CD accounts, their profits will evaporate and losses will mount.
Agreed, I edited to say big banks because they are the ones that will profit from the revival of M&A activity.
http://www.planbeconomics.com/2010/02/19/meredith-whitney-looking-for-bi...
"Meredith Whitney Looking for Bigger Bank Losses
Friday, February 19, 2010
Whitney believes believes the US banking system will lose 30% more than consensus estimates due to shrinking loan portfolios, and the possible end of extraordinary bond, currency and commodity trading gains.
. . ."
This is fantastic news! Since there is no longer any danger of a bank collapse, there should be no stigma in revealing who has borrowed at the discount window and who were the foreign recipients of those half $trillion in currency swaps, so Congress can now pass HR1154 with impunity!
O frabjous day!
I guess I'm just curious how all of this good news isn't just another example of "News is always best at a top"? I mean, I remember meeting with CEOs of large companies in 2007 and 2008 and them having not a clue what was about to happen and only being concerned with how to get in on "the next big thing", whatever that happened to be for their industry.
What are the bears missing that ISN'T priced into the market already? I mean, this whole "recovery" story is almost a year old and economic statistics are still being revised downward after their release. If the recovery was real, wouldn't they be getting revised upward?
Leo is smokin dope again.
Leo is smokin dope again.
As long as we allow banks to continue printing profits by taking stupid risks, the next financial crisis is only a matter of time.
Agreed. Also read Partnoy's 'F.I.A.S.C.O.' and 'Infectious greed'. There are trillions of losses hidden in the OTC derivatives market. Audit 0.001% of the OTC deriviatives market and our current system will collapse.