Finance, Banks and the SP500
With the stock market valuing one dollar of their earnings at $15 (price/earnings ratio) on average, are shares in U.S. regional banks set to fall? Most banks are drawing far too much earnings from yields on mortgage bonds and other securities they've bought recently--and far too little from commercial loans.
The problem is, banks borrow money to buy these securities and, while that cost is increasing, the yields on those securities are not rising to compensate. In Wall Street parlance, the yield curve is flattening, which means banks have to make more loans, or buy more bonds, to get the same kick to their earnings.
There is pressure on margins--and we've already seen this in the fourth quarter, Banks rely on short-term loans to fund themselves--that is, borrowings coming due in a year or less, which have rates that are likely to increase upon renewal. To see why that might be a problem now, consider how fast the gap between short-term borrowings and long-term loans has narrowed.
A prime example would be Commerce Bancorp with 65% of its earnings assets in securities. Like most regional banks, it trades at around 15 times forward earnings. Commerce has stated that it's not vulnerable to rising short-term rates, in part because it funds itself with an ever-larger pool of cheap--and even zero--interest-rate deposits. Indeed, so-called demand deposits actually grew in the fourth quarter by 7%. Yet, the New Jersey outfit's net-interest margin fell 13 basis points in the quarter anyway. The stock dropped 5% on the news.
The big question for Commerce and others: As short rates rise, will customers jump from bank to bank in order to get higher rates on their deposits, thereby squeezing margins further than investors anticipate? Some banks can take solice that 33% of all mortgages are ARMS, banks with higher ARM ratios in their portfolio will be more insulated from the "Carry Trade" contraction and fall out.
Food for thought...40 percent of S&P500 corporate profits are related to banks and financing...the FED will increase another 50 basis points by May to bring the overnight rate to 3%. There the FED should stop and pause to see the resulting reaction of the economy and the markets. The object is to acheive a "neutral" level, where neither inflation nor the economy are effected by interest rates, price stability is acheived, and the financial system remains solvent.
There has already been one natural tsunami this year, any increases over 3% will not only flatten the curve, they might precipitate a man made tsunami. And we already suspect that rates will go up much more than the markets are prepared for.
See archives: Treasury Debt
http://naybob.blogspot.com/2005_02_06_naybob_archive.html
See archives: Mortgage Debt
http://naybob.blogspot.com/2005_01_30_naybob_archive.html
The problem is, banks borrow money to buy these securities and, while that cost is increasing, the yields on those securities are not rising to compensate. In Wall Street parlance, the yield curve is flattening, which means banks have to make more loans, or buy more bonds, to get the same kick to their earnings.
There is pressure on margins--and we've already seen this in the fourth quarter, Banks rely on short-term loans to fund themselves--that is, borrowings coming due in a year or less, which have rates that are likely to increase upon renewal. To see why that might be a problem now, consider how fast the gap between short-term borrowings and long-term loans has narrowed.
A prime example would be Commerce Bancorp with 65% of its earnings assets in securities. Like most regional banks, it trades at around 15 times forward earnings. Commerce has stated that it's not vulnerable to rising short-term rates, in part because it funds itself with an ever-larger pool of cheap--and even zero--interest-rate deposits. Indeed, so-called demand deposits actually grew in the fourth quarter by 7%. Yet, the New Jersey outfit's net-interest margin fell 13 basis points in the quarter anyway. The stock dropped 5% on the news.
The big question for Commerce and others: As short rates rise, will customers jump from bank to bank in order to get higher rates on their deposits, thereby squeezing margins further than investors anticipate? Some banks can take solice that 33% of all mortgages are ARMS, banks with higher ARM ratios in their portfolio will be more insulated from the "Carry Trade" contraction and fall out.
Food for thought...40 percent of S&P500 corporate profits are related to banks and financing...the FED will increase another 50 basis points by May to bring the overnight rate to 3%. There the FED should stop and pause to see the resulting reaction of the economy and the markets. The object is to acheive a "neutral" level, where neither inflation nor the economy are effected by interest rates, price stability is acheived, and the financial system remains solvent.
There has already been one natural tsunami this year, any increases over 3% will not only flatten the curve, they might precipitate a man made tsunami. And we already suspect that rates will go up much more than the markets are prepared for.
See archives: Treasury Debt
http://naybob.blogspot.com/2005_02_06_naybob_archive.html
See archives: Mortgage Debt
http://naybob.blogspot.com/2005_01_30_naybob_archive.html
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