Bank stocks had their worst day since December 2018 on Tuesday after fears over the coronavirus pushed bond yields sharply lower for the second time in two days, threatening to worsen a profitability squeeze across the industry.
The share price rout came on the same day that the Federal Deposit Insurance Corporation, a US regulator, reported that US banks’ underlying profits fell in the fourth quarter of 2019 by the most since the financial crisis.
The KBW bank index fell 4.5 per cent, with rate-sensitive lenders such as Bank of America, Capital One and PNC Financial all falling by 5 per cent or more on the day.
The yield on the benchmark 10-year US Treasury bond fell to a record low and investors priced in multiple interest rate cuts by the Federal Reserve in 2020. As rates fall, the yield curve — the difference between short and long-term interest rates — tends to flatten or even turn negative, compressing profit margins on lending.
“The yield curve is what is causing the sell-off in bank stocks,” said Brian Klock, bank analyst at KBW. “Investors do not like to own banks late in the [economic] cycle and with the low and flat-to-inverted yield curve — that is not a good environment for net interest income.”
The FDIC’s Quarterly Banking Profile, released on Tuesday, showed that US bank profits were already falling sharply in the fourth quarter of last year. Net income at US banks fell 11 per cent in the quarter from the same period a year ago, the steepest drop in underlying profit since 2010.
The main reason for the profit drop — which excludes gains and losses on securities portfolios — was diminished returns on banks’ loan portfolios due to low rates and a flat yield curve. The profile reflects the results of 5,200 banks insured by the FDIC.
The only time since 2010 that bank net income has fallen as much was in the fourth quarter of 2017, when net income was hit by one-time, non-cash charges related to the Trump administration’s tax cut.
Jelena McWilliams, FDIC chairman, described bank performance in the quarter as strong, despite almost half of US banks reporting declines in profits. She noted that “loan balances continue to rise, asset quality indicators are stable, and the number of ‘problem banks’ remains low [while] net income at community banks improved”. (Community banks are small, typically with less than $1bn in assets.)
US banks’ net interest margins — the difference between loan yields and funding costs — declined to 3.28 per cent from 3.48 per cent the year before.
Bank revenues also fell in the fourth quarter, for the first time since 2016. Total loan growth decelerated to 3.6 per cent, from 4.6 per cent in the third quarter, dragged down by a decline in business lending.
The Fed cut rates three times in the latter part of 2019, and futures markets now indicate a further two cuts by January, according to data compiled by Bloomberg.
Bank stocks have priced in rate-driven declines in profits for several months now. Since the yield curve started to flatten most recently in December, bank shares have fallen 12 per cent, against a 3 per cent decline for the wider market.
Aaron Deer, analyst at Piper Sandler, said that banks are controlling costs and credit quality. “The reality is that bank performance, despite the margin pressure and a little slowing in loan growth, has been pretty consistent,” he said.
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