The Federal Reserve announced an extension of the Operation Twist program to the tune of $267 billion, to be spread throughout the rest of 2012. In the plan, the Fed will buy long-term securities (between 6 and 30 years) while selling an equivalent amount with maturities less than three years. This is expected to stimulate the economy by encouraging lending to both businesses and consumers, but may cause some damage to the major financial institutions which are still busy adapting to stricter regulations and intense scrutiny by the US government.
Since banks generally borrow money in the short term and lend in the long term, an overall flattening of the interest yield-curve should cut into banks' margins. While certain banks aren't as dependent on loan-based revenue, including Goldman Sachs (GS) and Morgan Stanley (MS), they are plagued by other concerns like weakness in investment banking and shrinking commissions in the securities business.
Citigroup (C) is one bank who is poised to take some damage. Its Global Consumer Banking (GCB) unit brings about half of the company's total revenue (based on the $10 billion figure gave in Q1 2012 out of a total of $20.2 billion overall), and represents the bulk of the bank's growth right now. Retail banking was particularly impressive, with a 37% gain in revenue year-on-year.
According to the company, the segment's growth was largely fueled by improvements in mortgages. Since some of securities involved in Operation Twist are mortgage-related, I expect that Citigroup's profits in this sector will be hurt from weaker net interest income on long-term loans. Citigroup is already having enough trouble reinstating its dividend (currently delayed until 2013) - the last thing the bank needs is a reduction of its profit margins.
Wells Fargo (WFC) is a major bank that relies on its net interest income, although it appears a bit more guarded than Citigroup with respect to mortgage income. About 50% of its revenue comes from interest differentials on its overall loan portfolio (net interest income). According to the last quarterly report, linked-quarter growth was primarily driven by commercial/industrial, auto, and student loans rather than mortgages. This does imply that Wells Fargo would be a bit less susceptible to adverse changes in the mortgage loan market.
Bank of America (BAC) has been stressed heavily by litigation fees, and still has other lingering issues to straighten out (as detailed by my recent article on the company). It is also highly susceptible to weakness in the loan markets (with 49% of its total revenue coming from interest income).
BofA's Consumer Real Estate services unit was a bit of an eyesore in the last quarterly report (Q1 2012, with a net loss of $1.15 billion), despite a $600 million jump in mortgage banking revenue relative to Q1 2011. Q1 2012 was still better than Q1 2011 for BofA's Consumer Real Estate unit, although future improvement needs to be driven by larger net interest incomes. This will be hard if margins in the mortgage industry get hit.
The takeaway here is that Operation Twist may make it much more difficult for all banks to grow revenue, especially for large consumer banks, since much of the Fed's operations are directly in mortgage securities. Some banks seem a bit more exposed to this than others (like Citigroup versus Wells Fargo), but the different valuations of bank stocks generally compensate the difference. While Operation Twist aims to increase the number of outstanding loans in the financial industry too, tougher regulations are discouraging this from happening due to the sad state of consumer credit.
So until 2013, the entirety of the banking industry should feel the effects of the Fed's twisting. The stocks are probably going to be fine in the long run, but they may feel a little sting.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
