Bank Chart Of The Week: Why It Doesn't Matter Which Banks Are Positively 'Gapped'

Includes: CMA, JPM, PNC, WFC, ZION
by: Harvard Winters

On any given day, a bank will originate, reprice or extinguish some dollar amount of assets and liabilities. Some floating rate loans will have their interest rates reset, new loans will be originated and others will be paid down. The same things happen on the liability side of the balance sheet. While this is happening, interest rates are fluctuating.

How can bank investors gauge the impact of changes in assets, liabilities and interest rates on a bank's net interest margin ("NIM")? One measure they use is one-year gap/assets ("Gap"), which is the dollar amount of rate-sensitive assets due to reprice or mature within one year less the dollar amount of rate-sensitive liabilities due to reprice within one year, divided by rate-sensitive assets. The result is a percentage. The more positive this percentage is, the more beneficial rate increases should be to the bank's NIM.

At least that is the theory. What does the data show? The chart below shows Gap information for Q1 2012 and Q1 2013 and the change in NIM over the intervening period for the twenty largest depository institutions by market cap (excluding the trust/processing banks). Data is provided by SNL Financial LC:

Most banks are positively "gapped" (positioned to benefit from a rate increase), some much more than others. Comerica (NYSE:CMA) and Zions (NASDAQ:ZION) have an especially large positive Gap. JPMorgan Chase (NYSE:JPM), in contrast, is more conservatively gapped, although its Gap has increased meaningfully over the last year. A large positive Gap given current market conditions isn't surprising. If you think rates are low today and poised to increase, you want your assets to be variable rate, so that they'll reprice when rates rise. In a more normal rate environment, you might not want to bet one way or the other.

But what's especially interesting is that when you overlay the percentage point increase in NIM over the prior twelve months, there doesn't appear to be any strong correlation between Gap and NIM change. Wells Fargo (NYSE:WFC)? Large positive Gap a year ago, large positive Gap now, big decline in quarterly NIM. PNC Financial (NYSE:PNC)? Similar gap to WFC, but a far less negative NIM change.

The reason? Each bank's asset mix (types of loans, and the mix of loans versus securities) and liability mix (types of deposits, and the mix of deposits vs. borrowings) is unique. And the same loan originated by two different banks on the same day could very well carry two different yields.

Keep in mind that, irrespective of how high a bank's Gap is, eventually all its assets and liabilities reprice. If rates increase suddenly and as a result a bank with a large Gap sees its NIM increase materially, the resultant earnings momentum will be short-lived. Nevertheless, its share price might spike. Buying one of the positively gapped banks in the above chart after such a spike is precisely the wrong time to buy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.