Low Rates Pressure Bank Margins

Lenders find it harder to boost profits and capital given current Fed policy.

Bank of America Corp. and Citigroup Inc. are among lenders that may find it more difficult to boost profits and capital after the Federal Reserve pledged to keep its benchmark interest rate low until at least late 2014.

“This hurts the banks, I don’t think there’s any question about that,” said Ralph Cole, a senior vice president of research at Ferguson Wellman Inc. in Portland, Oregon, which manages $2.9 billion. “Their cost of funds stays low but it makes it harder to earn a return.”

The Federal Open Market Committee said yesterday that economic conditions are likely to warrant “exceptionally low levels for the federal funds rate at least through late 2014.” The policy may hurt lenders’ profits as they struggle to find loans or securities with yields high enough to support their net interest margins, a gauge of profitability that measures the difference between the cost of funds and what they earn on assets.

The KBW Bank Index of 24 U.S. lenders advanced 0.1 percent, led by a 2.2 percent gain at Salt Lake City-based Zions Bancorp. Shares of U.S. insurers, including Radnor, Pennsylvania-based Lincoln National Corp., slid as investors bet lower yields will crimp income from corporate debt, municipal securities and mortgage-linked assets used by the companies to cover policyholder obligations and generate profits.

The average net interest margin at the four largest U.S. banks -- JPMorgan Chase & Co., Bank of America, Citigroup and Wells Fargo & Co. -- dropped to 2.99 percent in the fourth quarter from 3.17 percent a year earlier. The margin at U.S. banks with more than $15 billion in assets fell to 3.44 percent in the third quarter of 2011, from 3.85 percent in the first quarter of 2010, according to Fed data.

“As a bank investor, this is not a welcome response” from the Fed, said Peter Kovalski, a money manager at Alpine Woods Capital Investors LLC in Purchase, New York, which manages about $6 billion. Bank stocks “have had a good run here, but they could give back some of the gains in the next few weeks,” he said. The KBW Bank Index is up 11 percent this year.

Executives at New York-based JPMorgan expect low rates and the resulting margin compression to cause a $400 million decline in consumer and business banking net income this year, Barclays Capital analyst Jason Goldberg wrote in a report yesterday after meeting with bank management.


U.S. Unemployment

The Fed extended its previous pledge to keep rates low at least until the middle of 2013 as inflation remains tame and more than two years of economic growth failed to push unemployment below 8.5 percent. Some Fed officials have said further easing might be needed to put more Americans back to work and revive the housing market.

The Fed’s earlier pledge led San Francisco-based Wells Fargo to purchase more securities for its investment portfolio, Chief Financial Officer Timothy J. Sloan said in a Jan. 17 phone interview. Wells Fargo’s securities available for sale climbed to $222.6 billion as of Dec. 31 from $186.3 billion at the end of June.

“If the Fed had not said we are going to keep rates low, maybe we wouldn’t have invested as much, but they are the driver here,” Sloan said. “It’s silly not to take some of our liquidity, particularly because we’ve had good deposit growth, and invest it.”

The average yield on that portfolio fell to 4.46 percent in the fourth quarter from 4.92 percent in the third, the bank said last week in its earnings statement.

Banks may be able to cushion some of the negative impact of low rates if the Fed’s policy fuels economic growth and lending picks up, said Richard Staite, a London-based analyst with Atlantic Equities LLC. The yield on Wells Fargo’s loan portfolio was 4.81 percent in the fourth quarter.

“The best thing the Fed can do is promote economic growth, even if that requires a sustained period of low interest rates,” Staite said in a phone interview. “Loan growth will be the most important factor to helping banks offset the negative impact of low rates.”

Ferguson Wellman’s Cole said he’s worried about the potential for banks to make riskier loans if they grow desperate for income.

“At some point they won’t be able to make a return on their money so they will have to lend more,” said Cole, whose firm owns shares in Citigroup, JPMorgan and Wells Fargo. “Hopefully that doesn’t mean the loan quality goes down. They start reaching for yield, and that’s when they get hurt.”


Mortgage Rates

The Fed’s pledge is likely to further trim mortgage rates, which are linked to long-term government bond yields, said Greg McBride, the senior financial analyst at Bankrate.com, a unit of Bankrate Inc. Credit-card lenders, betting that their funding costs will remain low, also may boost or extend offers for zero-interest balance transfers, he said.

The national average rate on deposits, which includes checking, savings and money-market accounts, and certificates of deposit up to five years, is 0.59 percent, according to Dan Geller, executive vice president of Market Rates Insight in San Anselmo, California. That’s the lowest since he started tracking the data in January 1990. Interest rates on deposits may reach zero within the next 12 months to 18 months if lending continues to be soft, he said.


Custody Banks


Low interest rates also hurt custody banks by reducing the returns they make on investments and from lending cash and securities to institutional investors such as mutual funds and hedge funds. Bank of New York Mellon Corp., Boston-based State Street Corp. and Chicago-based Northern Trust Corp., the three largest independent custody banks, have made or planned 4,450 job cuts since November 2010.

The Fed’s announcement signals more difficulty for U.S. money-market mutual funds, which have waived some of their fees to keep customers’ returns above zero. The average annual fee charged by the largest 100 money funds fell to 0.17 percent in December, from 0.37 percent in August 2008, according to Crane Data LLC in Westborough, Massachusetts. Money fund assets had declined 31 percent in the past two years to $2.66 trillion as of Jan. 17.




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