America fact of the day

US bank stocks have suffered a brutal start to 2016. Out of the 90 stocks on the S&P financials index, just seven were in positive territory for the year, after the market closed on Monday.

Two of the biggest losers, Bank of America and Morgan Stanley, are down 27 per cent and 29 per cent respectively. Citigroup, also down 27 per cent, is now trading at just 6.5 times earnings, not far off the trough of 5.9 times during the Lehman Brothers crisis.

That is from the FT.


Oh well, not to worry.

Analysts and strategists have been recommending bank stocks on the premise that higher rates are good for them.

But the relative performance of the S& P index of bank stocks only has about a 0.5 correlation with yields.

Moreover, the claim is that when rates rise banks can charge higher rates. But the historic record shows that since the Fed started announcing their fed funds target the spread between fed funds and the prime rate has essentially been a constant at 2 percentage points. As soon as the Fed announces a different target rate the banks change the prime rate.

One of the reasons banks appear to make more money when rates are higher is that the composition of their investment portfolio changes. Early in the cycle banks invest heavily in low yields treasuries. But as the economy matures the switch out of low yield treasuries into higher yielding loans. But that switch has not been happening very much this cycle so this source of higher earnings has not materialized..

Third, quality spreads move in lock step with capacity utilization and as the world economy slows quality spreads have widened as investors have become more and more concerned with the quality of banks outstanding loans.

So why should anyone be surprised that as growth has slowed that bank stocks have underperformed.

Good. My high school English teacher told me that the non-fiction classic Grapes of Wrath teaches us that this is to what our laissez faire financial system would inevitably lead. Nationalize the banks now!

Why stop at just the banks?

Feel: Your HS English teacher was not an economist or a historian.

The US financial system has not been a Laissez faire system since, arguably, 1913 (Federal Reserve Act) or more reasonably 1933 (Glass Steagall).

FDR felt that one of his top three legacies was banking regulation. Social Security and collective bargaining were the other two.

US banking is heavily regulated and over-competition causes weak margins.

A problem is constricting net interest margins (NIM). Currently NIM are in the low three-percent range, formerly around four-percent. Bank borrowing and deposit rates may have near-zero floors, not so loans. Lenders must have spreads (loan interest income less interest expenses) of about 3 percentage points, or they can't operate.

Another weakness may result from Basel III/higher capital minimums and potentially lower returns on equity unless banks increase margins which may entail added risk-taking.

In the near future, FASB will require US banks to alter their accounting for loan losses. Currently, it is an incurred loss estimate. In the near future, it will be an amount measured based on current estimated credit losses (CECL). Bankers believe that will require additional loan loss reserves and charges/reductions to net operating income.

Asset quality problems may be worsening. Commercial real estate loans are being underwritten based on very low cap rates in appraisals, a condition seen in the run up to the 2007 real estate bubble bust. Low cap rates indicate that market participants believe that market values will soar. They had the same beliefs in the early 2000's. We know how that ended.

His HS teacher was apparently not well versed in the difference between non-fiction and fiction, either. In fact, The Grapes of Wrath won the Pulitzer Prize for fiction in 1940.

Sadly, the ability to distinguish between "fiction" and "non-fiction" seems to be a rare these days.

"...a rare thing" (indeed).

So what? Stock prices go up and down. Do those prices really have an effect on the profitability of the banks? The banks were better off when they were private, rather than publicly traded companies.

Bank stocks didn't exactly set the world on fire in 2015, either. Some seemed to be testing highs, but failing to beat them, which is usually a warning sign for a full reversal.

So what?!?

What do banks produce?

Just debt, and they want more debt so they can extract rents from the churn of debt.

I remember when we were promised higher interest on our savings deposits and lower borrowing interest rates that would be easier to get once Regulation Q was eliminated.

Oh, how happy am I that my savings earn .1% instead of 5% at an S&L and I can borrow $10,000 at 36% and more without having a job or assets instead of not being able to borrow anything at 12% unless I had a job history that showed I could repay the debt, or else Sears would come take the washer or the car dealer the car.

And bank regulation is so wonderful that no longer are we offered a toaster to open a free checking account and dealing with an expensive teller to get passbook interest creduted, and now get charged $25 per month for checking and use of an ATM where the labor costs are so low it requires paying a ATM transaction fee.

What a terrible imaginary world you inhabit

Who pays ATM fees, other than drunks in strip clubs and casinos?

My credit union gives me 10 free withdrawals at other institutions ATMs and belongs to network of over 25,000 ATMs across the country.

Plus the regional convenience store giant also has fee-free ATMs.

In the twenty years since ATM fees were authorized, I have paid a fee just twice. Once was right in April 1996, the first week the fees were in effect. I didn't know about the change and was unprepared. The other was in 2001 when I was a rest stop in Delaware and the Roy Rogers didn't take credit cards.

"...Roy Rogers didn’t take credit cards."

But I heard Dale Evans did...

It's all good, man.

I received in today's mail a credit card offer: 0% interest for 21 months; never an annual or late fee. I need to read the small print. This sounds like a win-win situation for me.

I intend to buy gold with that interest-free, 21 month loan, and pay it off before I pay any interest. Sweet!

In an elegant boardroom, somewhere in Washington DC in 2008, a hustler was heard saying, ... because Citigroup *is* to big to fail.

The next day I began calling banks and credit unions and asking questions. A credit union representative assurred me, her organization couldn't offer a mortgage with Citibank's terms.

A week later, I had closed my Citibank savings and checking account and opened accounts at Provident Credit Union.

It's the globalization, stupid! Cowen has been warning for a long time that globalization is fraught with risk (even as he praised his favorite city-state). And international banks are exposed to the same risks as globalization. In the linked article in FT, it's suggested that investors switch to US-focused lenders. The genie is out of the bottle, and it's not that simple to put back. I call it the black hole of globalization - shifting enormous amounts of productive capital to the previously under-performing economies in technology and growth from previously over-performing economies in technology and growth and both technology and economic growth disappear.

rayward, Can you flesh this idea out some? Is it possible that capital just isn't worth that much anymore, and that given the options, emerging markets might still be the best place for capital to seek out return? This is not rhetorical, I have honest interest in your viewpoint. It seems overseas expansion for many companies is/was a no-brainer, while investing at home made little economic sense.

I'm thinking in particular of the rapid "catch up" growth experienced in China as an example thinking that there are/should be large opportunities in developing economies.

thanks for the viewpoint,

A number of recent research papers have shown that technology and economic growth across economies and countries varies greatly, that certain places do much better than others over long periods. There are many explanations but the phenomenon is very real. To have an enormous shift of productive capital from economies with a history of technology and growth to economies with the opposite and expect the latter economies to suddenly be like the former economies is to ignore history and logic; it's more wishful thinking than informed investing. The black hole metaphor is meant to signal not only less technology and growth but disappearing technology and growth, opportunities for technology and growth lost forever. It's conventional wisdom that less developing economies, once provided with productive capital, will race to catch up, resulting in even greater technology and growth than if the same productive capital had stayed in developed economies. But what if rather than racing to catch up those developing economies continue to fall behind, with much of the technology and growth consumed in the black hole. It's also conventional wisdom that capital invested in Silicon Valley will realize a better return than capital invested in other places because so much human capital is present in Silicon Valley, that the concentration of that human capital acts like an accelerant for technology and growth. Two conventional wisdoms that can't co-exist.

Thanks rayward. I haven't heard this. I'm trying to think through how these investments might make sense at the firm level, but in aggregate be less than the sum of the parts. In my own finances I'm looking at investing in emerging markets currently given the multi-year poor performance, so it's important to know if that is where capital goes to die. ;-) thank you again.

Do you think the poor performance of those banks' stocks reflects political factors--perhaps the notion that in an election year where Sanders can get ahead by bashing the big banks, the prospects of too-big-to-fail banks might be a little worse than in other years?

As Bernie's stock rises, banks' fall.

Unlikely Bernie will win. I think Republicans will win this time somehow.

No they reflect the fear that the banks are going to get slammed with loan defaults in the near future.

uggg, "Banks" are not "America"

If you want to get nervous, look at preferred shares.

US examples, please? So far it seems to be a Canadian/European thing.

iShares U.S. Preferred Stock ETF is down 8.8% in the last year, less than the S&P 500:
it dropped over 60% from top to bottom 2007-2009.

Actually, American banks have been among the best bank performing stocks in the world. The European banks (Deutsche Bank, the Canadian banks, all the Italian banks and the Greek banks in particular) have had far larger declines.

This suggests that the problem isn't simply domestic asset quality issues or domestic regulations or too much competition, but rather yield curve shape, worldwide overregulation, and slowing foreign economies.

"worldwide overregulation"

I laughed.

In deed loool

"But when confidence disappears, banks tend to bear the brunt of the sell-off. Matt O’Connor, analyst at Deutsche Bank, notes that in 15 corrections going back to 1983, the US banks sector has been hit roughly twice as hard as the rest of the market — regional banks about 1.8 times worse, and capital markets-focused banks about 2.3 times worse."

I wish it said 15 of x corrections defined by y, etc.

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