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Tom Brown’s Dire Outlook for Banking

Posted by Larry Doyle on June 11, 2012 11:04 AM |

Most market participants are understandably focused on immediate developments in the Euro-zone and the implications of the shell game being played over there for our domestic economy and markets.

From my perspective, the perpetual kicking of the can down the road in Europe and the variations thereof here in the U.S. portend little more than an ongoing slow-motion train wreck for our global economy.

While central bankers try desperately to keep the train on the tracks, the easy money flowing into the system does not come without very real costs. Ask savers and individuals trying to live on a fixed income what a 0% Fed Funds rate does for them. Who else is being negatively impacted? The banking industry at large.

Really, how is that? 

Their NIM is getting squeezed. Their what? The net interest margin which represents the spread between the banks’ cost of funds and the returns generated on their asset base.

Top rated banking analyst Tom Brown offered a dire outlook for the banking industry this morning during a Bloomberg radio interview. Brown offered that in looking at the forward curve for interest rates, the market is projecting a 2% Fed Funds rate in 2020. From there, he projected under that interest rate scenario the banking industry will have shrunk by 25%!!

Wow. Talk about a dire outlook. In the current environment, with the overnight Fed Funds rate of 0% and a 10 Yr. U.S. Treasury benchmark rate of 1.6%, banks are getting squeezed in terms of generating positive spread. Adding fuel to this fire, with the outlook for the net interest margin in the banking industry not improving anytime soon, banks will be under real pressure to maintain their credit ratings. Potential downgrades will only put further pressure on banks. The large Wall Street banks without a consumer deposit base (Morgan Stanley especially but Goldman Sachs as well) are facing the prospects of a downgrade very soon.

A lower credit rating implies a higher cost of funds and a further squeezing of the net interest margin. The downward spiral, which is already well underway, will result in a contraction of the industry. What else will it likely mean?

I would project that those institutions with real influence — that is, the largest banks — will exert ever increasing pressure on their political cronies and ineffectual regulators to back off so they can generate revenues and further solidify their position within a contracting industry. The Wall Street oligopoly will likely gain even greater market share. This is not good. What does this mean?

Consumers and investors should be ever more vigilant for predatory practices. Developing personal relationships with individual bankers and advisors whom you fully vet and thoroughly trust is already important but will be even more so in the future.

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

 

  • Peter S.

    Desperate people (and entities) do desperate things.

  • coe

    Isn’t it interesting, LD, that one unintended consequence of Fed easing – specifically formulated to encourage economic growth through low borrowing rates for businesses and consumers – is the fact that the interest rate environment puts a horrible squeeze on a bank’s ability to create margin. One consequence of this phenomena is a natural inclination to seek alternative ways to create revenues – eg witness Jamie Dimon’s directive to his portfolio folks to get more involved with credit product and derivatives – that didn’t turn out too well, did it..The calculus is simple – banks make money by taking interest rate, credit and/or duration risk…traditionally, banks took credit risk through their own customer lending activities – not in the securities portfolio or synthetically off-balance sheet…in this Fed manipulated rate environment, though, both interest rate and duration approaches will not work in any meaningful way…that leaves the credit risk path…yet, the regulators have been hammering banks to be careful about their underwriting standards – and it just isn’t that easy for mom and pop or small businessman to qualify for a loan – despite near zero rates – hence the urge to create credit earnings via the portfolio or synthetically – or both…quite the conundrum…bankers need to convince the analysts, rating agencies, and their investors that this new world order is a paradigm shift…the days of 15% return on equity are over…more capital cushions required by militant global regulators chasing the horse after it has left the barn plus punier net interest margins mean any current ratio comparisons to the salad days of yesterday will fall flat…mama, don’t let your children grow up to work in financial services or banking! and citizens – heed LD’s warning to read the fine print in all of your financial transactions…in the immortal words on Hill Street Blues, “Be careful out there”!

  • Bill

    For a fabulous read and review of the pressures which the large Wall Street banks are facing in their trading businesses,

    Was JP Morgan’s Loss the End of An Era for Global Banks?






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