Magazine article American Banker

Analyst: Low Rates Threaten Bank Profits and Share Prices

Magazine article American Banker

Analyst: Low Rates Threaten Bank Profits and Share Prices

Article excerpt

Low interest rates, long viewed as rocket fuel for bank stocks, could ultimately hurt earnings and stock prices, one industry analyst cautions.

"Midsize and smaller banks in the United States could be facing a difficult two years from an earnings standpoint," since rates are likely to fall further, said Richard X. Bove of Raymond James & Associates Inc., St. Petersburg, Fla.

Conventional investor wisdom holds that banks are hurt by higher rates. Mr. Bove and many other analysts dispute that, but investors still tend to sell bank stocks whenever yields on Treasury securities rise, assuming damage to bank earnings.

And in extreme cases, this is true. When the Federal Reserve doubled interest rates in 1994 and 1995, bank profits were chilled, and their stocks caught cold.

Since then, rates have fallen back significantly, and banks have enjoyed some of their strongest earnings ever. The lower-rate environment has fueled bank stocks' dramatic rise.

"It is a very good environment for banks. We have a strong economy, low inflation, and healthy margins," said Sung Won Sohn, chief economist at Norwest Corp. "Banks suffered in 1994 and 1995. The asset quality was good, but the margins were shrinking."

Nevertheless, Mr. Bove, anticipating even lower rates and perhaps deflation because of the Asian financial crisis, has been steadily paring back his banking recommendations since last fall.

His reasoning is concise: Since 1970, bank earnings have fallen in every year that the federal funds rate has declined. The funds rate, controlled by the Fed, is the overnight rate for loans of reserves between banks. …

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