Bank Stocks' Fed 'Destruction' Will Hit Hard in 2013
On Tuesday, Wells Fargo chief financial officer Timothy Sloan warned of the problem in a presentation at the Barclays Global Financial Services conference, highlighting that the bank's portfolio of bond securities carrying pre-crisis yields faces maturities that will push interest earnings lower. Wells Fargo now expects interest margins to fall 17 basis points and resemble year-ago levels in the third quarter.
Sloan highlighted two key factors: declining gains from the write up of credit-impaired loans acquired during the crisis
Previously, those factors helped Wells Fargo more than double net interest earnings since 2007. While interest earnings have risen modestly as a result of the Wachovia acquisition, interest cost is off roughly 60% in the past five years. For JPMorgan, the liquidation of its 'Chief Investment Office' after a $5.8 billion trading loss may be a similar earnings hit.
"This is the reality of a low interest rate environment. Sooner or later, it catches up to you," says Nancy Bush, the head of bank research firm NAB Research. "We are at sort of coming to the point of greatest destruction over the coming year," she says.
Cannon of KBW highlights Wells Fargo as the most exposed large cap bank to the negative impact of interest rate dynamics. In contrast, he counts credit card lenders like Capital One and Discover Financial, and US Bancorp, which earns a lot of fee-based revenue, as banks that may come out relatively unscathed.
A way for Wells Fargo and other large cap banks to cushion against falling earnings would be to significantly ramp up loans, which carry an earnings opportunity even at 4% to 5% rates compared with low cost deposits, notes Cannon. In comments made to the press after announcing QE3, Fed chairman Ben Bernanke noted that loan growth has been a missing element at large banks, even as recent quarterly earnings were buffeted by rising mortgage refinancing's.
Still, as CFO Sloan indicated on Tuesday, extending loans at record low rates carries a big risk if rates do rise sharply, signaling that bank CFO's and investors face a bit of a guessing game on the impact of Fed policy, that's tempering animal spirits.
Meanwhile, some lenders like Citigroup may have seized upon four years of beneficial Fed policy to prepare for what may be an industry-wide earnings drain.