Twist This


america-money.jpgYour country needs you. Your country needs you to go into debt, that is.

Hoping to jumpstart a lackluster lending environment, the Federal Reserve recently announced “Operation Twist” to drive down long-term interest rates such as the 30-year fixed-rate mortgage while increasing short-term interest rates.

The idea, a much bigger replay of a 50-year economic program of the Federal Reserve during the Kennedy administration, is that the move will make long-term borrowing more attractive, which could encourage home buyers to buy homes and businesses to invest in job creation.  But will it?

Scott Brown, the chief economist and senior vice president for Raymond James & Associates, says the Federal Reserve’s $400 billion program of buying and selling U.S. Treasury securities is trying to get banks to lend more, possibly by squeezing the interest margins that banks depend on. This interest margin is the difference between the interest banks charge on loans and the interest they pay out for deposits. As their profits get squeezed, the banks could increase lending to make more money.

But will they?

“With banks in a much better position than they were three years ago, the Fed is betting that a flatter curve, and margin compression, will not cause undo strain, but instead lead them to make up the difference in loan volumes,’’ Brown writes in his weekly commentary. “We’ll see.”

The problem with such an approach is that there are few high-quality borrowers out there wanting to get loans, and the banks have worked hard to improve the credit quality of the assets on their books. The idea that they would stretch their underwriting guidelines to offer more loans is doubtful, and whether their regulators would even allow it is also doubtful.

What could really spur lending is for more high-quality borrowers to somehow come out of the woodwork looking for loans at record low interest rates. But many potential homebuyers can’t sell the homes they do have or take advantage of low rates to refinance as home values continue to decline. Freddie Mac announced this week that the average 30-year fixed-rate mortgage fell to a record low of 4.01 percent as of Sept. 29.

In contrast, the short-term, five-year adjustable -rate mortgage rate ticked up after the Sept. 21 announcement by the Federal Reserve from 2.99 percent to 3.01 percent. It has remained flat since then, according to Freddie Mac.

Whether all this will spur lending is another matter.

“We question whether this program can be successful because we believe the lack of borrowing and lending activity has more to do with other fundamental economic and regulatory conditions than it does with interest rates,’’ writes G. David MacEwen, chief investment officer of fixed income for American Century Investments.

He goes on to describe the Federal Reserve’s toolbox as “nearly empty.”

It may be that the Federal Reserve is in the same boat as the Obama administration: there’s not that much more it can do to incentivize a reluctant and hobbled private sector. The government would like you to borrow, but will you?

 

Why bank stocks are performing so badly


You can almost hear the wind come out of the recovery.

John Duffy, the chairman and CEO of investment bank Keefe, Bruyette & Woods gave his update on the state of the banking industry at Bank Director’s Bank Audit Committee conference in Chicago June 14, and it wasn’t a pretty picture.

As of early June, the recovery in bank stocks has stalled. This, despite the fact that 63 percent of bank stocks tracked by KBW beat analyst expectations in the first quarter.

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That’s quite a change from the depths of the recession, when 73 percent of banks missed analyst expectations, back in the fourth quarter of 2008.

“I think there is some credibility being established between analysts and bank management, but unfortunately, the economic news is not always good,’’ Duffy said.

Credit quality has improved but non-performing assets still are high. Deposit growth has slowed dramatically. And even the biggest banks, which were more aggressive than the regional banks in terms of provisioning for bad loans, don’t have much room for growth.

“As you shrink the balance sheet, it’s hard to replace those assets,’’ Duffy said. “I think a lot of the optimists have now gone to the sidelines and are less convinced that the economic recovery is going to continue and that obviously has implications for loan volume in the banking industry as well as credit quality.”

Duffy said bank stock analysts are probably going to be focused on the fact that net new non-accruing loans (non-performing loans whose repayment is doubtful) rose in the first quarter for the first time in six quarters.

With all the loan problems and regulatory pressure, investment bankers such as John Duffy, who depend on M&A as their bread and butter, having been predicting a coming wave of consolidation.  It hasn’t happened yet.

With just 60 traditional, non-FDIC-assisted acquisitions this year through June 3, valued at about $3 billion in total, Duffy said he thinks it’s been difficult to raise capital, especially for banks below $1 billion in assets. Plus, there’s a lack of potentially healthy buyers in regions with a lot of hard-hit banks.

“We should think there are at least a couple hundred banks that are not going to make it,’’ he said. “For the banks that are healthy, we continue to think this remains a real opportunity.”

What Falling Home Prices Mean for Banks


skydive.jpgThe most recent S&P/Case-Shiller Home Price Indices declined 4.2 percent in the first quarter of 2011 on top of an earlier 3.6 percent drop in the fourth quarter of 2010. “Nationally, home prices are back to their mid-2002 levels,” according to the report.

If you are a connoisseur of home price data—and the countless expert predictions since the market’s collapse in 2007—you know that the housing market should have bottomed out by now and been well into its long awaited recovery. There was a slight rebound in housing prices in 2009 and 2010 due to the Federal Housing Tax Credit for first-time homebuyers, but that rally pretty much died when the program expired on Dec. 31, 2009. Now, housing prices are falling again like a skydiver without a parachute.

Recently I called Ed Seifried, Ph.D., who is professor emeritus of economics and business at Lafayette College and a partner in the consulting firm Seifried & Brew LLC in Allentown, Pennsylvania, to talk about the depressed housing market and its impact on the banking industry. Seifried is well known in banking circles and was a keynote speaker a few years ago at our Acquire or Be Acquired conference.

“We’re pretty close to a structural change in housing,” Seifried says. You, me and just about everyone else (including, apparently, former Federal Reserve Chairman Alan Greenspan) was taught that home prices always go up—sometimes by the rate of inflation, sometimes more—which made it a pretty safe investment. “That dream has pretty much been shattered,” Seifried continues. “The Twitter generation is looking at the European (housing) model, which is smaller and more efficient. Your home shouldn’t be a statement of your wealth.”

A broad shift in housing preferences could have important long-term implications for the U.S. economy, since housing has been one of our economy’s engines of growth for decades. What is absolutely certain today is that a depressed housing market is hurting the economy’s recovery after the Great Recession, and that has broad implications for the banking industry.

A depressed housing market translates into a depressed mortgage origination industry, which has significant implications for the country’s four largest banks—Bank of America, J.P. Morgan Chase, Citigroup and Wells Fargo—which have built giant origination platforms that might never again churn out the outsized profits they once did. In fact, I wouldn’t be surprised to eventually see one or two of them get out of the home mortgage business if Seifried’s structural change thesis is correct.

Community banks that lent heavily to the home construction industry during the housing boom are either out of business or linger on life support. But even those institutions that did not originate a lot of home mortgages, or lent heavily to home builders or bought lots of mortgage-backed securities are being hurt because housing’s problems have become the economy’s problems.

In a recent article, Seifried points out that for the last 50 years housing has contributed between 4 and 5 percent of the nation’s GNP. In the 2004-2006 period, that contribution rose to 6.1 percent.  In 2010, housing accounted for just 2.2 percent of GDP—and dropped to 2.2 percent in the early part of 2011. Seifried also estimates that the housing market accounts for 15-20 percent of all U.S. jobs when “construction and its peripheral impacts are weighed.”

“It’s difficult to imagine an overall economic recovery that can generate sufficient jobs to return the U.S. economy to full employment without a return of housing to its historical share of GDP,” he writes.

In our interview, Seifried told me of a recent conversation he had with a bank CEO who thought his institution was reasonably well insulated from the housing market’s collapse because it had made relatively few construction loans. But that bank still experienced higher than expected loan losses because of all the other businesses it had lent to that ended by being hurt by the housing downturn.

Indeed, virtually no bank in the country is immune to the housing woes because banks—even very good and very careful ones—require a healthy economy to thrive. The U.S. economy needs a strong and growing housing market to thrive, and that doesn’t seem to be anywhere on the horizon.

 

Bankers Are Starting to See the Glass Half Full


Things are looking up. The tide of optimism has definitely turned since the first quarter of this year. In our recent survey of bank executives, 45% say they believe the U.S. economy will improve within the next six months. This demonstrates a sizeable increase from the 24% who were similarly optimistic in our first quarter 2010 survey. While the bulk of respondents are still in the camp that believe the economy will likely remain the same over the near term, (44%), we noted a drop by nearly half among those who believe that harder times are still ahead (11%, compared to 20% six months earlier).

Moreover, among those who were asked how well their local economies are faring, a similar strain of optimism is found. Thirty-five percent (compared to 22% in the first quarter) believe their local economy is poised to improve, and only 9% (compared to 18%) believe things will get worse within the next six months.

Compliance concerns remain high. Among the concerns that bank executives have over the next 12 months, regulatory concerns overwhelmingly stand out above the rest. Fully 87% of bank executives ranked regulatory burden as a major concern over the next 12 months—nearly 30 points higher than the next, most pressing concern: exposure to commercial real estate losses (58% ranked it as a major concern.) In third place, but much lower than either of the first two, was a concern over retaining quality talent (37% ranked as a major concern.)

Watch out for commercial real estate. The largest percentage of bank executives surveyed (35%) believe the shoe will drop on commercial real estate values sometime within the next 12 months, but that opinion is far from unanimous. Another quarter of the surveyed group (25%) believes commercial real estate values already have bottomed out; and another 24% believe it will happen in the next six months. Not surprisingly, perspectives on this question have a lot to do with one’s region. Forty-two percent of the central region think their values have already bottomed out, compared to only 10% of bankers in the southern region and 18% of those in the western region who think so.

Who is raising capital? With the regulatory scrutiny placed on capital standards in the wake of the financial crisis, we asked bank executives to tell us their anticipated plans with regard to capital raises in the next 12 months. Less than a quarter of the total surveyed (22%) say it is very likely they’ll go to the market to raise capital, but a higher percentage of those from the still-troubled Southeast (37%) say they’ll do so. The majority (67%) say such action is not likely in the next 12 months. Finally, a small group (11%) said they had already successfully undergone a capital raise.

For the complete survey results and graphic analysis, watch for Bank Director’s third quarter issue mailing later this month.