Why U.S Banks Want Higher Interest Rates

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1114_rising_rates_630x420Banks have had a good run since being bailed out by taxpayers in the financial crisis. By lowering its target interest rate to almost zero in 2008, the Federal Reserve allowed the banks to pay much less for the money they borrow to lend and invest. That helped the four largest U.S. banks by assets report about $214 billion in profits from the end of 2008 through the third quarter of this year.

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Even so, the Fed’s low-interest-rate policy has been a mixed blessing for banks. Along with lowering their borrowing costs, it’s limited what they can charge on loans and earn on other investments. The difference between the two—the net interest margin—has been declining since 2010. Brian Moynihan, chief executive officer of Bank of America, told analysts on a July 16 conference call that the “sustained low-rate environment” was hitting revenue and earnings. That’s why bankers and bank stock investors have a simple wish for 2014: higher interest rates.

When rates rise, lenders try to raise the amount they charge for loans faster than what they pay on deposits. Through the first six months of 2013, investors bet that the Fed would reduce its $85 billion in monthly bond purchases, which would lead to higher rates and, in turn, improve profit margins at U.S. banks. Their buying pushed the KBW Bank Index of the 24 largest lenders up 20 percent in the first half of the year.

Events played out in a more complicated way. On May 22, Fed Chairman Ben Bernanke hinted at slowing bond purchases; over the next four months 10-year Treasury yields rose about 1 percentage point, hitting 3 percent on Sept. 5. Since bond prices fall when rates rise, banks were hit with billions of dollars in losses on their bond portfolios. The higher rates also led to a plunge in mortgage refinancings, which had accounted for almost three-quarters of all home lending, depriving Wells Fargo (WFC), JPMorgan Chase (JPM), and other banks of billions in revenue. Then weaker-than-expected economic data led Fed officials to delay cuts in bond purchases, leaving banks in the same low-interest-rate trap.

That’s why stability is such a focus for 2014. “Higher rates improve the profitability of banks,” says Christopher Lee, a money manager who specializes in financial stocks at Fidelity Investments. “If the environment improves next year, I think they are well prepared to capture that growth.” Investors and bankers also say a rate rise could herald an improving economy and stronger demand for banking products such as consumer loans, credit lines, and mergers-and-acquisitions advice. In an environment like that, “you have to get very excited about our business,” Gary Cohn, chief operating officer of Goldman Sachs (GS), said in an Oct. 23 Bloomberg TV interview.

The turmoil of 2013 illustrates how a sudden move in the market can catch lenders off guard and erode the perceived advantage of rising rates, according to William Isaac, a former chairman at the Federal Deposit Insurance Corp. and now chairman of Fifth Third Bancorp (FITB). Isaac is concerned that the longer the Fed maintains low rates, the worse the shock will be when they head higher. “The big unknowns are how fast and how high will interest rates rise,” he wrote in an e-mail.

Bernanke said on Sept. 18 that the Fed may not raise a key short-term rate—the rate banks charge each other for overnight loans—before U.S. unemployment falls “considerably below” 6.5 percent. It was 7.3 percent in October. Only 4 of 65 economists polled by Bloomberg expect the central bank to raise the overnight rate before 2015. The three-month Treasury bill rate will climb to 0.42 percent by the end of 2014, while the yield on the 10-year Treasury note will climb to 3.33 percent, according to economists surveyed by Bloomberg. The 10-year yield was 2.53 percent on Oct. 22.

If short-term rates stay low and long-term rates rise, as economists expect, that could curtail profits since many bank loans are tied to shorter, floating rates, says Robert Albertson, head of investment strategy at Sandler O’Neill & Partners. While higher long-term rates allow banks to invest excess cash at more attractive yields, loan pricing is “the bigger factor” for bank profits, he says.

Savers are hurting after a 30-year run during which interest rates fell from a high of 20 percent to near zero, where they’ve been stuck since 2008. Customers tired of low yields may be quick to seek out competitors offering more attractive deposit rates, setting off bidding wars among banks, according to Nancy Bush, an independent analyst. “The banks won’t have the luxury of lagging deposit rates this time,” she says.

Babatunde Akinsola
Babatunde Akinsolahttps://naija247news.com
Babatunde Akinsola is aNaija247news' Southwest editor. He's based in Lagos and writes on the Yoruba Nation political issues, news and investigative reports

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