I’ll be the first to admit I like cheap mortgage rates. Who doesn’t, right? If you’re going to buy a house, all else being equal, you’d like to pay 3.5 percent for a 30-year fixed mortgage rather than 4.5 percent. And those are the kinds of figures we’ve been seeing, in part because of the Federal Reserve’s relentless infusion of interest rate medicine.
There’s just one problem: That medicine is now sickening the banks! That, in turn, is threatening to actually make it HARDER to obtain mortgage credit — or any credit, for that matter!
Let me explain why …
Falling NIMs Hitting Bank Income
Ben Bernanke and his cohorts have claimed repeatedly that they’re just trying to help mainstream America by driving down interest rates and buying assets willy nilly. I, on the other hand, have described a myriad of unintended consequences.
I’ve explained how those very same low rates are killing Americans who rely on interest income to support their lifestyle. It’s forcing retirees to pinch pennies, for instance, or chase ever-riskier types of bonds just to generate enough yield to pay their bills.
I’ve also proven how each successive round of money printing has driven up “bad” assets like commodities right alongside “good” assets like stocks. That makes QE a completely useless policy for the real economy — because rising gas and grocery costs erode disposable income, offsetting the supposed “wealth effect” of higher asset prices.
Now, it’s becoming clear that too much low-rate medicine is actually starting to drive a knife through the heart of the banking sector. That’s because it is crushing “NIMs.”
The acronym stands for Net Interest Margin. In plain English, it’s the difference between what banks pay out in interest on deposits and what they earn in interest on loans or investments.
The wider the margin, the more profitable a bank’s core lending and deposit-taking operation is. And the more profitable a bank’s core operations are, the more money it’s willing to loan and the more risk it’s willing to take on. Of course, the opposite is also true … and that’s the crux of the problem!
You see, the Fed has already slashed short-term rates to within a few basis points of 0 percent. Yields on many bank accounts have followed the Fed’s lead, heading steadily toward — or all the way to — 0 percent. But rates can’t go into negative territory. So that means bank “input costs” have fallen almost as far as they can.
Meanwhile, the Fed is artificially and aggressively suppressing rates on long-term investments and loans, such as mortgages, mortgage backed securities, corporate debt, and more. That means that as each old loan matures, or each old investment is paid off and retired, the bank has to make a new loan at a lower rate, or buy a new security that yields less. Each unit of bank “output” is therefore generating less revenue.
|The Fed’s next-to-zero interest rate policy has cut bank margins to the bone.|
NIMs have collapsed from the high-3 percent range to just 3.12 percent at the nation’s largest banks. SNL Financial says that’s the lowest in three years! And it’s not just a few banks, either; Keefe, Bruyette & Woods says margins fell at 79 percent of the banks it tracks in the third quarter.
What Profit Margin Pressure Means for Financial Stocks … and Lending Overall!
Many regional and super-regional banks are seeing their stock prices break down as a result. BB&T (BBT) is one example; its shares have shed almost 15 percent of their value since the QE-inspired rally in September thanks to increasing margin pressure. Regions Financial (RF), PNC Financial (PNC), and Wells Fargo (WFC) are two others that are starting to slip.
I find this trading action important because financials were previously the prime beneficiaries of the cheap money trade. If they’re now becoming the prime victims of it, the broad market could be in big trouble. After all, stocks are already under pressure thanks to lousy earnings in technology, industrials, and materials.
Then there’s the overall economic impact. The Fed thinks it’s helping by attempting to drive down mortgage and other loan rates and bond yields. But just like with any patient, at some point too much medicine becomes toxic rather than helpful.
If banks can’t make money making loans and investing excess funds, they’re going to pull in their horns. They’re going to make fewer loans and take on less risk. That will make an already tight mortgage market even tighter, and constrict the flow of credit to businesses large and small.
So keep an eye on this trend! The implications for bank stocks and the economy as a whole are huge!
Until next time,
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