Bank CEOs are acknowledging that new Fin Regs have created a brave new world for banks. Yesterday, at Goldman Sachs’ Financial Services Conference, both Bank of America’s and Citigroup’s CEOs warned that fixed income trading revenues will be disappointing in the fourth quarter of 2014. They also painted a dour picture of fixed income trading revenues going forward.
According to regulators, proprietary trading should not be a core business of large systemically important banks. If banks want easier Fin Regs, they can shrink. This is one of the goals of new Fin Regs. To look back at bank profitability during any of the last few recoveries is utterly useless. Conditions are very different. If valid comparisons could be made, one might compare today’s environment to the early Glass-Steagall days. Maybe a historical look is warranted. We just have to look back farther than many experts believe.
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Many bank sector bulls and economic optimists have hung their hopes on rising rates to lift bank profits. What needs to be understood is that it is not simply the interest rate that banks collect on loans which determines lending profitability, but the difference between the cost which banks pay for capital and the rates they charge on loans. This is known as the net interest margin. In any business, profitability is all about margins (wholesale and inputs costs versus revenues from sales). It is no different for banks.
This makes it all the more puzzling that market participants would see Fed tightening as a boon to bank profitability. After all, one of the goals of Fed tightening is to contain inflation by curtailing borrowing and, thus, spending. When the Fed tightens, the yield curve usually flattens. It is common knowledge that a flattening yield curve usually harkens a slower or contained economic environment in the not-too-distant future. As such, we do not see a Fed tightening as a boon to lending unless household income expands to the point that they can take on higher levels of debt. However, data indicate that household debt levels remain fairly high and more deleveraging probably has to occur before consumers can even contemplate ramping-up leverage.
What leverage consumers have been taking on, has been in the form of auto leases and loans. Some loans (particularly among less creditworthy borrowers) tend to have longer tenors and higher interest rates. This does not bode well for home equity and credit card driven spending.
We consider Fed tightening as a modest negative for lending expansion because even if incomes begin to rise a bit, tighter net interest margins could make banks less willing to part with capital. However, lending to well-qualified borrowers should continue, even with tighter net interest margins. Such loans are not considered to be very risky.
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
- November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
- December 2011 – November 2012 – Bond Squad, Kunkletown, PA
- April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
- June 1986 – March 1988 – E.F. Hutton, New York, NY
Director of Fixed Income
Wealth Strategies & Management LLC