Fed could slow bank recovery

The central bank's move to buy $300 billion in Treasurys may pump up mortgage volume, but loans won't be as profitable as they once were.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By David Ellis, CNNMoney.com staff writer

chart_10_year_yield.03.gif

NEW YORK (CNNMoney.com) -- The Federal Reserve's latest program to buy massive amounts of government debt could provide a helping hand to the economy - but not so much for bankers.

Treasury prices rallied sharply Wednesday after the central bank revealed plans to purchase $300 billion in long-term debt over the next six months. But it also sent corresponding yields plummeting.

The yield on the benchmark 10-year note, for example, suffered its biggest single-day decline in more than 20 years. Rates on shorter-term debt fell in tandem on the news, but to a much smaller degree. (Bond prices and yields move in opposite directions.)

That is troubling for banks, which typically borrow money at short-term interest rates and make long-term loans.

"Normally banks do well when the yield curve is steep," said Gerald Hanweck, a finance professor at George Mason University's School of Management.

At a time when banks face numerous headwinds -- including rising loan losses and ongoing weaknesses in the housing market -- the gap between long and short term rates, or the slope of the so-called "yield curve", has been one of the few bright spots for banks lately.

Last quarter, a period of severe strain for the industry, banks generated about $97 billion in profits from the money they took in and lent back out. That's up 4.9% from $92.5 billion during the same period a year ago, according to the latest industry reading by the Federal Deposit Insurance Corp.

What got rates to this level in the first place was the Fed's aggressive rate-cutting campaign, which accelerated as the financial crisis gathered momentum last fall.

Many analysts believed that the steepness of the yield curve would allow those banks that were not completely overwhelmed with bad loans or toxic securities to earn their way out the crisis. But now those hopes appear to be diminishing.

"It could backfire a little on the Fed by weakening bank earnings which aren't that strong to begin with," said Hanweck.

Details remain scant about the Fed's Treasury buying program, although the Federal Reserve Bank of New York indicated earlier this week that the purchases would focus on Treasurys with two- and five-year maturities.

What may vex bankers further is the length of the program. Purchases are expected to take place 2 to 3 times per week on average for the next six months.

"The Fed has definitely put a cap on interest rates," said Mary Ann Hurley, vice president of fixed income trading at D.A. Davidson in Seattle.

Certainly, the program has its benefits. By buying government bonds, the Fed hopes it can bring down interest rates on a wide variety of debt, including mortgages. To that end, the Fed also said Wednesday it would buy $750 billion's worth more of mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac.

If these efforts help lead to even lower mortgage rates, it could coax many potential homebuyers back into the market or spark a rash of refinancing activity. That stronger loan volume, notes Jennifer Thompson, senior analyst at the New York-based financial services research firm Portales Partners, would help compensate for any premium lost as a result of a flattening yield curve.

"For the banks that are big mortgage originators, the move in the 10-year [Treasury] would be the most impactful," she said.

Still, some experts fear that the program could work to the disadvantage of many smaller lenders, which make up the lion's share of the more than 8,300 institutions that populate the nation's banking industry.

Unlike their larger peers, community banks have largely been shut out of many of the government programs aimed at salvaging the banking sector and alleviating the credit crunch.

Hanweck notes that many smaller banks cannot access the Federal Reserve's Term Asset-Backed Securities Loan Facility, or TALF, to make a loan on the cheap.

"The top 20 [banks] have borrowing advantages that the smaller ones just don't have," he said. To top of page

Features
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
15 top executives with $1 salaries Some CEOs and founders agree to salaries of just $1 a year. But once goodies like bonuses and stock options are added in, some of those executives end up taking home many millions of dollars a year. More
Mercedes SL65 AMG: 621 horses of topless power Turn heads as you blow by traffic in this roadster convertible from Mercedes. More
Where the middle class is most unequal CNNMoney looks at the five states with the biggest differences in middle class incomes. More
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.