The Need To Listen To The Big Banks

Includes: BAC, C, GS, JPM, MS, WFC
by: John M. Mason

This week there will be an important conference when four of the largest US banks will give us some insight into how banking profits are evolving.

The focus will be on what is happening to the net interest margins of banks as longer-term interest rates have dropped and the yield curve has become inverted.

Information on the future of the industry might be gathered as these interest rate issues add difficulties to the structural changes taking place due to the impact of information technology.

This week we will get some evidence about how bad the current situation might be in the commercial banking industry.

Longer-term interest rates have fallen and the yield curve has shown more inversion.

The 10-year US Treasury note closed to yield 2.012 percent on July 31, 2019.

One month later, on August 30, 2019, the 10-year US Treasury note closed to yield 1.500 percent.

This yield has dropped as low as 1.465 percent on September 4th before closing out the week at 1.551 percent.

The yield on the 10-year US Treasury note dropped below the yield on the 2-year US Treasury note on August 14 and remained below the shorter rate until September 3rd, but at the close of last week remained only two basis points above the rate on the shorter maturity.

This information is not good news to the commercial banking industry that historically has thrived off of the difference between longer-term interest rates and shorter-term interest rates.

The net interest margin earned by the banks is the foundation of commercial bank performance.

A lower net interest margin will have an important impact on bank profits.

That is why analysts are waiting to see what some banking leaders are going to say at this week’s Barclays Global Financial Services Conference being held in New York.

Jamie Dimon, JPMorgan chief executive, John Shrewsberry and Jon Pruzan, respectively, the Wells Fargo finance head and the Morgan Stanley finance chief, and Tom Montag, president of Bank of America, will give their updates on the current financial picture.

The view of the future is not expected to be a good one,

The view for these “large” banks, however, will be better than might be expected for others within the industry, because these larger banks earn more fee income than do others within the industry.

Still, the writing on the wall is pretty clear.

The banking environment has changed.

The projections for economic growth in the near term have become more modest.

The concerns over a trade war have become more ominous.

And, the Federal Reserve has begun a new regime, one that will bring on even lower interest rates.

This is not the best of all pictures for the banking system.

The bigger banks can get some benefit from all the uncertainty that accompanies an environment like this because the increased volatility of financial markets can produce a lot more fee income that would tend to accrue to primarily the largest.

However, many of the largest banks have, in recent years, tried to reduce the role of fee income in their overall performance.

Regional banks and others do not have this other source of income so that a reduction in net interest margins will hurt them more in the overall picture.

Thus, if the banking system faces such an interest rate picture for an extended period of time, the largest six banks will be relatively better off in terms of profit performance than other banks and this will only extend the growing strength of the biggest banks over their smaller rivals.

The bottom line on this is that all banks will be harmed by an extended period of lower interest rates and an inverted yield curve, but the relative harm will be greater to the banks that are smaller in size.

Add this to the competitive benefits the largest banks are achieving through scale economies and you see a banking system that is consolidating into fewer, but larger institutions.

It is getting harder and harder to see how the banking system of the United States is going to maintain many of the smaller banking institutions over the next five to ten years, especially if interest rates remain at historically low levels.

The next year or two might be very disruptive in this sense because of the macroeconomic factors currently impacting the economy. Look for the bigger banks to take advantage of this situation and gain an even further hold on the structure of the banking system.

Thus, it will be very instructive to hear what comes out of the Barclay conference.

We sill specifically hear from JPMorgan, Chase, Wells Fargo, Bank of American and Morgan Stanley. But, we can expect that there will also be representatives from Goldman Sachs and Citigroup.

This conference could be very important in presenting a picture of a “tipping point” for the industry.

Disclosure: I/we 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.