How The Yield Curve Helps Banks.
A good article on the current positives for banks. I think it is a good illustration on how banks make their money which I think is helpful to many of my clients and readers. Whether their "fundies" are offset by all the dilution from the issued common remains to be seen.
Banks' Outlook Not as Dire as Stock Prices {excerpt}
Can we put aside for a minute all the jitters over this week's selloff in the 10-year Treasury note and what it all means for the global economy? Let's worry about that tomorrow. Whatever else the note's recent tankage portends, the associated 20-basis-point jump in the 10-year's yield created a milestone of its own: The yield curve is now steeper than it's ever been. For banks, that's really, really good.
I doubt I have to explain you why, either. Remember how the banking business works? Banks take in deposits that either pay no yield at all (in the case of checking accounts) or pay a yield tied to short-term interest rates (in the case of savings accounts). Then they turn around and lend those deposits at a longer-term interest rate. So when the yield curve steepens, as it is doing now, banks' net interest margins tend to go up. Which is to say, banks' profitability is expanding as you read this very sentence.
This yield-curve-steepening business isn't the only good thing going on with the banking business lately. Several other events are occurring that, prior to the industry being tossed into the investment community's doghouse, would have been considered bullish. For one, the financial system has come a long way toward recovering from its freeze-up in September following Lehman's collapse. Credit spreads have narrowed generally, on everything from corporate credits to junk.
And as Bloomberg reported on Thursday, the Federal Reserve is no longer the system's buyer of first, last and only resort....{C}redit the Fed has extended to financial institutions is off by 38% since the start of the year, to $701 billion. So increasingly, borrowing and lending is going on without the help of the federal government.
In the meantime, the "green shoots" in the economy that everybody seems to be talking about apparently aren't figments of anyone's imagination. Thursday morning, for example, unemployment claims came in better than expected (claims, a key leading economic indicator, have clearly passed their peak), while April durable-goods orders were notably strong. Consumer confidence, another leading indicator, is rising fast.
Put it all together -- widening net interest margins, a return to normalcy in the financial system and credible signs of an economic recovery -- and it's not hard to imagine a steady, rapid recovery in bank profitability in coming quarters. Yet the stocks seem to be priced as if the credit crisis is going to last more or less forever.....not only are the stocks not trading as if a fundamental recovery is visible; some are trading as if they face years and years of losses. Which they don't.
The steepening of the yield curve is only the most recent piece of encouraging news to hit the banking business lately. The pieces are in place for a broad industry recovery. It's just the stocks' valuations that have yet to catch up.
I doubt I have to explain you why, either. Remember how the banking business works? Banks take in deposits that either pay no yield at all (in the case of checking accounts) or pay a yield tied to short-term interest rates (in the case of savings accounts). Then they turn around and lend those deposits at a longer-term interest rate. So when the yield curve steepens, as it is doing now, banks' net interest margins tend to go up. Which is to say, banks' profitability is expanding as you read this very sentence.
This yield-curve-steepening business isn't the only good thing going on with the banking business lately. Several other events are occurring that, prior to the industry being tossed into the investment community's doghouse, would have been considered bullish. For one, the financial system has come a long way toward recovering from its freeze-up in September following Lehman's collapse. Credit spreads have narrowed generally, on everything from corporate credits to junk.
And as Bloomberg reported on Thursday, the Federal Reserve is no longer the system's buyer of first, last and only resort....{C}redit the Fed has extended to financial institutions is off by 38% since the start of the year, to $701 billion. So increasingly, borrowing and lending is going on without the help of the federal government.
In the meantime, the "green shoots" in the economy that everybody seems to be talking about apparently aren't figments of anyone's imagination. Thursday morning, for example, unemployment claims came in better than expected (claims, a key leading economic indicator, have clearly passed their peak), while April durable-goods orders were notably strong. Consumer confidence, another leading indicator, is rising fast.
Put it all together -- widening net interest margins, a return to normalcy in the financial system and credible signs of an economic recovery -- and it's not hard to imagine a steady, rapid recovery in bank profitability in coming quarters. Yet the stocks seem to be priced as if the credit crisis is going to last more or less forever.....not only are the stocks not trading as if a fundamental recovery is visible; some are trading as if they face years and years of losses. Which they don't.
The steepening of the yield curve is only the most recent piece of encouraging news to hit the banking business lately. The pieces are in place for a broad industry recovery. It's just the stocks' valuations that have yet to catch up.
As an aside I used to work for the same company as Matt. He is very smart and understands banking very well.
posted by CR English at 9:40 AM
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