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ParticleMan

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Don't say you weren't warned...

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aQGncwk4vFlk

July 27 (Bloomberg) -- The Federal Reserve’s policy of keeping interest rates persistently low, which has helped boost bank earnings over the last six quarters, is beginning to make it harder for the biggest U.S. lenders to make money.

Firms including JPMorgan Chase & Co. and Bank of America Corp., which have benefited from record low costs of funding mortgages and other assets, face a squeeze on their net interest margins -- the difference between what they pay to borrow money and what they get for loans and on securities. Analysts say the margins may have peaked in the first half and that banks will struggle to replace high-yielding assets as they pay off.

The Fed’s near-zero target rate for interbank overnight lending that has buoyed profits for so long will have an opposite effect in coming quarters, said Christopher Whalen, a Federal Reserve Bank of New York analyst in the 1980s and co- founder of Institutional Risk Analytics in Torrance, California.

“That’s the gift from the Fed,” Whalen said of the rate. “But at the same time, the cash flow on your assets eventually starts to re-price and match the low-rate environment. The zero- rate environment is eventually bad for everybody.”

Net interest margins fell by 26 basis points to 3.06 percent at New York-based JPMorgan from the first to second quarters, 17 basis points at Citigroup Inc. to 3.15 percent and 16 basis points at Bank of America to 2.77 percent, according to company reports. A basis point is 0.01 percentage point.

‘Massive Issue’

The reduced margins, along with lower lending volumes, translated to a drop in net interest income of $1.02 billion at JPMorgan, the second-largest U.S. bank by assets and the largest by market value. Net interest income fell $849 million at Bank of America, the biggest lender by assets, and $522 million at New York-based Citigroup, which is third.

“It’s a massive issue for the industry, impacting banks at different timing,” said Matt O’Connor, an analyst at Deutsche Bank AG in New York. “The universal banks -- Bank of America, Citi and JPMorgan -- are feeling the pressure now and will continue to feel pressure for the foreseeable future.”

Brian Moynihan, 50, chief executive officer of Charlotte, North Carolina-based Bank of America, told analysts on a July 16 conference call that the “sustained low-rate environment” was hitting revenue and earnings and will continue to affect margins. JPMorgan CEO Jamie Dimon, 54, told analysts the day before that the bank’s net interest margin will continue “coming down a bit as we reposition the portfolio.”

Wells Fargo

Wells Fargo & Co., the fourth-biggest bank, reported that net interest margin increased by 11 basis points to 4.38 percent in the second quarter, which the bank said was the result of higher-than-expected income from soured mortgage loans.

By lowering its target rate to almost zero in 2008, the Fed helped save many banks from collapse. The move reduced the industry’s average cost of funding mortgages and other interest- earning assets to 1.03 percent in the first quarter of this year, the lowest rate on record according to the Federal Deposit Insurance Corp., from 3.58 percent in the third quarter of 2007.

While it also depressed the yield banks earn on their investments and loans to 4.86 percent from 6.93 percent over the same time period, the net interest margin hit a seven-year high of 3.83 percent in the first quarter, according to the most recent FDIC data available.

Fed Signals

The Fed has signaled that slowing inflation and a sluggish economy will push any interest-rate increase into 2011. It said in a June 23 policy statement that “underlying inflation has trended lower” and repeated a pledge to keep the benchmark interest rate near zero for “for an extended period.”

The language led most economists polled by Bloomberg to predict the Fed won’t raise rates until the second quarter of next year. Futures traded on the CME Group Inc. exchange showed a 37.6 percent likelihood yesterday that the benchmark lending rate will be raised in April 2011. That likelihood was 55 percent a month ago.

“Once you get into this low-rate environment for 12 to 18 to 24 months, somewhere in there assets start re-pricing to the lower interest-rate environment,” said Marty Mosby, a Memphis, Tennessee-based analyst with Guggenheim Partners LLC.

Banks, reluctant or unable to lend, are shrinking their balance sheets. That’s starting to eat into cash flow at the biggest lenders.

‘No Loan Demand’

JPMorgan’s balance sheet was reduced by $121.8 billion in the second quarter to $2.01 trillion, which is also down from a peak of $2.25 trillion in the third quarter of 2008. Citigroup’s total assets fell by $64.6 billion in the second quarter to $1.94 trillion. Wells Fargo’s total assets, which were up $2.2 billion from the first quarter to $1.23 trillion in the second, have fallen from a peak of $1.31 trillion in December 2008.

“There’s no loan demand, and long-term rates have declined so much,” Deutsche Bank’s O’Connor said. “So as you look out over the next few quarters, it’s a potentially very dire situation for the overall industry.”

Loans generate some of the highest yields for banks, said Jason Goldberg, an analyst at Barclays Capital in New York.

“In an environment where loan growth is tough to come by, it’s a tough challenge,” Goldberg said in an interview. “When your highest-yielding asset isn’t there to put on the balance sheet, it’s tough.”

Goldberg said banks are getting squeezed as the yield curve, which charts the difference between rates on short- and long-term debt, flattens out. The spread between yields on three-month Treasury bills and 30-year Treasury bonds fell to 387 basis points July 23, down from 471 basis points January 11, the highest level in at least a decade, according to data compiled by Bloomberg.

Regional Banks

Because most banks tend to fund their long-term investments such as 30-year mortgages with short-term debt, they benefit when short-term rates are lower and make less money when short- and long-term rates come closer together.

“Generally, the steeper the curve, the better,” Goldberg said. “It’s steep by historical standards, but it’s not as steep as it was earlier this year.”

Regional banks won’t start feeling the pain until later this year or early next year, partly because their reliance on deposits for funding has insulated them from broader market shifts, O’Connor and other analysts said. The average rate paid on checking-account deposits was 0.53 percent on July 13, the lowest level since February 2005, according to Bankrate.com.

‘Hit the Floor’

“We’ve hit the floor in deposits, you can’t go any lower, and your asset yields are declining,” said Nancy Bush, a bank analyst and co-founder of NAB Research LLC, an Annandale, New Jersey-based independent research firm. “So there’s only one way to go for the margin, and that’s down.”

PNC Financial Services Group Inc. said its cost of deposits in the second quarter fell to 71 basis points from 81 basis points in the first quarter and 125 basis points a year ago. Those lower funding costs won’t be enough to offset the yields the Pittsburgh-based bank is earning from securities, mortgages and credit cards, Chief Financial Officer Richard Johnson told analysts on a July 22 conference call.

“This downward trend reflects the continuing migration of the portfolio to lower-risk asset classes, such as U.S. Treasury and U.S. agency mortgage-backed securities, along with the impact of the lower-rate environment,” Johnson said. “Yields on securities will continue to decline as we replace maturities and prepayments with lower-risk securities.”

Johnson said the bank, the sixth-largest by deposits in the U.S., will generate lower yields and profit margins in the second half of the year.

“When banks can’t find yielding assets and their book is shrinking, the cash flow on their book is shrinking,” said Whalen of Institutional Risk Analytics. “Everybody’s starving to death.”

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What are they going to do increase rates? That's going to kill the debt based economy totally.

There is no way out of this mess, the bankers have destroyed themselves with greed.

no, it will kill the weaker banks...only this time the poor ones have had 3 more years to really frack themselves up. they havent changed a bit.

I look out the window, and the grass and wheat are growing, the cows are chewing, I hear the sheep baaing...nope. the real world continues unabated, but the make beleive infinity is real banking world is collapsing in a heap of reality.

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What are they going to do increase rates?

Slam the borders shut*?

That's going to kill the debt based economy totally.

Figuratively, then quite literally**.

(* Protectionism)

(** War)

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Guest Noodle

Slam the borders shut*?

Figuratively, then quite literally**.

(* Protectionism)

(** War)

No ones going to war and protectionism has been rife throughout the pseudo-globalisation era (Asian barriers to your exports) hence the trade imbalances.

They know it's their fault as much as ours and suspect both sides will co-operate to rectify the situation.

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suspect both sides will co-operate to rectify the situation.

I keep hoping for this too.

But here we are, old borrowing is being refinanced at lower rates compressing the margins of the lenders, decapitalising them in the process, and creating a feedback loop where tighter spreads result in less money lent (and at lower velocities) hence reducing asset valuations hence reducing both equity and income available to be drawn against and so ad infinitum.

Perhaps the Fed's next trick will be price controls (ie, regulating a minimum spread on lending)?

soviet-supermarket-009.jpg

Edited by ParticleMan

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Guest Noodle

I keep hoping for this too.

But here we are, old borrowing is being refinanced at lower rates compressing the margins of the lenders, decapitalising them in the process, and creating a feedback loop where tighter spreads result in less money lent (and at lower velocities) hence reducing asset valuations hence reducing both equity and income available to be drawn against and so ad infinitum.

Perhaps the Fed's next trick will be price controls (ie, regulating a minimum spread on lending)?

soviet-supermarket-001.jpg

Still no reason to vapourize 3 billion people within half an hour of each other just because some geeky Porsche driving banker couldn't use a calculator, even the type with big buttons on it.

calculator1_800.jpg

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Still no reason to vapourize 3 billion people within half an hour of each other just because some geeky Porsche driving banker couldn't use a calculator, even the type with big buttons on it.

Ain't democracy* grand.

(* I think it was Bonaparte who quipped that "the unemployable registered voters march on their stomach"... or something - my French is a little rusty admittedly)

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Very informative article. The great profits we are seeing at the banks right now is because they have refinanced their debt from the fed at low rates, while people in 5 year mortgage terms are still at higher rates from before.

Raising interest rates at the fed would make the situation worse, not better.

Ultimately the only way out is to get loan demand going again. And the only way to do that is when people start making more money, when there is opportunity for business to expand, when the mass of consumers have tons of money to spend and money is flowing around the economy.

Since the banks literally cannot grow their loan books because of no demand, the only way is massive fiscal deficits and printing to get money into the economy.

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Since the banks literally cannot grow their loan books because of no demand, the only way is massive fiscal deficits and printing to get money into the economy.

Some sort of ... new... deal?

The problem here is that as fast as the Fed adds liquidity (printy freaking printy) the market will remove it again (bidding below par at auction*, viz the great Trojan experiment in the not-so-distant past).

Dobbins is dead and overdue for the glue factory - it's time for the policy makers to stop flogging the old boy.

(* of much greater concern would be the near-immediate flattening of the curve, with the long bond dropping to the overnight rate in what I strongly suspect would be the space of weeks - for those of you not already exhaling tea through your septum, this really would be an "operational challenge" for the world of credit as we know it today)

Edited by ParticleMan

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What are they going to do increase rates? That's going to kill the debt based economy totally.

There is no way out of this mess, the bankers have destroyed themselves with greed.

commercial banks will pass the low rates onto deposit customers.

For some accounts this may require a negative nominal rate of interest, which could be implemented as a 0% paying account with a small annual fee, and a maximum balance.

They will be able to do this, since the whole banking market needs to widen spreads, and the only way to do that is down, on the deposit side, so competition will ensure that the market moves as more or less a whole. Further, as long as any net fees for depositing are still lower than the carrying cost of paper cash, people will still deposit, although they may move more money into CDs.

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For some accounts this may require a negative nominal rate of interest, which could be implemented as a 0% paying account with a small annual fee, and a maximum balance.

Broadly speaking, a market response to present conditions of "well we're out of ideas too, if you think you can do better then take the damn stuff back and 'ave-a-go."

Or more succinctly, and mostly directed at those with positive real balances held in short-dated maturities (ie, deposit holders) - "shit or get off the pot".

I have no idea, none whatsoever as to what stunt the Fed's about to pull.

But it's pretty damn obvious to me that they'll do something different, and soon...

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Broadly speaking, a market response to present conditions of "well we're out of ideas too, if you think you can do better then take the damn stuff back and 'ave-a-go."

Or more succinctly, and mostly directed at those with positive real balances held in short-dated maturities (ie, deposit holders) - "shit or get off the pot".

I have no idea, none whatsoever as to what stunt the Fed's about to pull.

But it's pretty damn obvious to me that they'll do something different, and soon...

Their mandate is to hit the 2% inflation target. In times when inflation is racing ahead of that they have to move to reduce liquidity. If like now inflation is at 1% and falling, with private credit creation going strongly negative.. its obvious they have to loosen monetary policy.

They about doubled the fed balance sheet to 2.4 trillion. Which helped things a lot and saved the system. But was not enough to kick start the private economy to take over by itself. So the next step is to expand the fed balance sheet to 5 trillion. And then sit back and watch the effects of that increase to decide the next course of action.

If that doesn't work then QE 3.0 will be to expand the fed balance sheet to 10 trillion. Eventually it will be enough to get money rolling in the private economy. Then once the private economy takes over credit creation, it will be time to scale back some of the QE, and to start raising interest rates.

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To me the only question left in the present is how is the fed going to spend the QE. The theory calculatedrisk has is that Bernanke will probably use it to bring down the rates on the longer termed bonds. Perhaps with an explicit guaruntee that if rates rise above x% the fed will buy whatever it takes to drive them below again.

But will the fed buy agency mortgage debt, longer dated treasuries, high rated corporate bonds, perhaps even other sovereign debt.

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commercial banks will pass the low rates onto deposit customers.

For some accounts this may require a negative nominal rate of interest, which could be implemented as a 0% paying account with a small annual fee, and a maximum balance.

They will be able to do this, since the whole banking market needs to widen spreads, and the only way to do that is down, on the deposit side, so competition will ensure that the market moves as more or less a whole. Further, as long as any net fees for depositing are still lower than the carrying cost of paper cash, people will still deposit, although they may move more money into CDs.

Do you charge extra for adding complication?

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Broadly speaking, a market response to present conditions of "well we're out of ideas too, if you think you can do better then take the damn stuff back and 'ave-a-go."

Or more succinctly, and mostly directed at those with positive real balances held in short-dated maturities (ie, deposit holders) - "shit or get off the pot".

exactly. no doubt it would cause much wailing and gnashing of teeth but the question - so what are you going to then remains. Put up or shut up.

I have no idea, none whatsoever as to what stunt the Fed's about to pull.

But it's pretty damn obvious to me that they'll do something different, and soon...

QE is a stock thing that is supposed to, but doesn't, feed into flows directly. I imagine the next action is to target flows explicitly.

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If that doesn't work then QE 3.0 will be to expand the fed balance sheet to 10 trillion. Eventually it will be enough to get money rolling in the private economy. Then once the private economy takes over credit creation, it will be time to scale back some of the QE, and to start raising interest rates.

Ah, the explanation for QE 3.0. I'm sure QE 4.0 will be justified in a similar fashion.

For me, it doesn't feel like shit or get off the pot. More like we're going to force feed you until you shit, and then if you don't we're going to reach in and pull the damn stuff out.

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Ah, the explanation for QE 3.0. I'm sure QE 4.0 will be justified in a similar fashion.

For me, it doesn't feel like shit or get off the pot. More like we're going to force feed you until you shit, and then if you don't we're going to reach in and pull the damn stuff out.

We're all being turned into foie gras geese then! (or for me UK faux gras duck!) :unsure:

Edited by duckwomanloulou

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To me the only question left in the present is how is the fed going to spend the QE. The theory calculatedrisk has is that Bernanke will probably use it to bring down the rates on the longer termed bonds. Perhaps with an explicit guaruntee that if rates rise above x% the fed will buy whatever it takes to drive them below again.

But will the fed buy agency mortgage debt, longer dated treasuries, high rated corporate bonds, perhaps even other sovereign debt.

indeed..what is ANYONE going to spend all this extra credit on..

demand for loans is on the Wane.

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  • 140 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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