Deflation Might Hurt Bank Profits & U.S. Economy
Wednesday May 7, 4:34 pm ET
By Jonathan Stempel
NEW YORK (Reuters) - Large U.S. banks that expected interest rates to rise later this year might see their profits take a hit if Federal Reserve Chairman Alan Greenspan's deflationary nightmare comes to pass, analysts said on Wednesday.
"It would be a disaster," said Anton Schutz, who runs the $165 million Burnham Financial Services Fund. "I want to ask CEOs, 'At what level would you consider not lending?"'
Deflation, a period of falling prices, became the talk of markets after the Fed, in a surprise to some, on Tuesday said "the probability of an unwelcome substantial fall in inflation" exceeds the chance that inflation might rise. Inflation was a mere 0.9 percent annualized in the first quarter.
Though the Fed left its key lending rate at a four-decade low of 1.25 percent, its saber rattling cheered economists hopeful the central bank will do what it takes to get the economy moving, and avoid a Japan-style deflation, which has helped keep that country in recession for more than a decade.
But for banks, the warning is worrisome. "Most banks have set themselves up for rising interest rates," said David Long, senior research analyst at Robert W. Baird & Co. in Chicago.
Deflation and low rates go hand-in-hand, and low rates cause banks' "net interest margin" -- the difference between what they pay on deposits and earn on loans -- to shrink.
"In a true deflationary environment, you have no pricing power," said Denis Laplante, managing director at Fox-Pitt, Kelton Inc. "For banks, it might not be possible to pass on some costs to the customer."
Last quarter, margins at Bank of America Corp. (NYSE:BAC - News), Wells Fargo & Co. (NYSE:WFC - News) and many rivals shrank 0.1 to 0.5 percentage points from a year earlier. Most were readying for a late 2003 economic recovery and a modest rise in rates.
"I don't believe there is any chance of deflation in America," said James Dimon, chairman of Bank One Corp. (NYSE:ONE - News), the No. 6 U.S. bank, on an analyst conference call last month.
The bank missed analysts' earnings forecasts in part because it lost money betting on an eventual rate rise. Bank One was not immediately available for further comment.
WIGGLE ROOM
Banks have little room to maneuver.
As savers know, many bank accounts already pay puny yields, and according to BankRate.com the average yield on one-year certificates of deposit is now 1.69 percent.
If rates fall further, these yields should fall, but rates on banks' own loans should fall more.
"There may be a tiny bit banks can do on the CD side, but if the Fed cuts rates, all of the lending and consumer loan rates, and many commercial rates, would head south," said Bob Maneri, an analyst for Victory Capital Management in Cleveland, whose $62 billion of assets includes shares in many banks.
Moreover, deflation would also suggest a weak economy, which often make it harder for consumers and business to pay their debts. This might lead to more defaults.
"You have to ask if banks are going to have a longer period of credit losses," said Bob Millen, a principal at Jensen Investment Management in Portland, Oregon. His firm owns shares of mortgage financiers Fannie Mae (NYSE:FNM - News) and Freddie Mac (NYSE:FRE - News) because more refinancings might help their business.
Though banks in general aren't yet publicly betting on falling rates, they are concerned.
"Most of the bank managers I talk to are still cautiously optimistic about the economy for the second half of the year or beginning of 2004," said Long. "But, I haven't spoken to anyone seeing a pickup in commercial loan demand."
(Additional reporting by Andrea Hopkins in Washington) |
