Banks have crashed with third-world debt and multiple times with too much real estate exposure. What’s next? Could it be too much exposure to low interest rates. Chris Whalen has penned a piece for ZeroHedge.com called “Zombie Dance Party: Same Girls, New Music.”
In most of the piece Whalen goes on about the potential for Bank of America stock to double in price over the next year given that the banking giant is trading a half of its book value.
But the more interesting point is that net interest margin is shrinking for 2 out of every three banks. So how are they making their money? As this space has pointed out before, it’s primarily been through taking money out of loan-loss reserves, but also, as Whalen points out, “The fact that the TBTF banks are relying on fee income and line items like investment banking to hit revenue and earnings targets is very telling.”
Large bank efficiency ratios are still north of 60% which means the industry’s expenses are still too high for its revenue stream. As it is, with the Fed’s Zero Interest Rate Policy (ZIRP), the only income to be had is selling debt assets inflated by the Fed’s policy. And so the cul-de-sac dead ahead for bank stock investors and banks, Whalen colorfully describes,
Most institutional investors, keep in mind, have no idea how the TBTF banks actually make money. So when well-meaning Sell Side analysts predict wondrous stock price appreciation for the Zombie Dance Queens, the proverbial sheep on the Buy Side sing with joy — and rush into the interest rate trap so lovingly constructed by Chairman Bernanke and the Fed. Keep in mind that the corollary of ZIRP is massive interest rate and market risk on the books of all banks. Think trillions of dollars in option adjusted duration risk.
Banks are hooked on the ZIRP that Bernanke is cooking and promises to serve up until 2015. Whalen writes,
Without the benefit of gain on sale from mortgage origination and securitization, it is difficult to construct a long term bull scenario for any US bank, large or small. As and when the Fed normalizes interest rates, the business models of the TBTF banks are going to be far less exciting. Mark-to-market losses on securities will wipe out stated earnings. New and innovative ways of presenting “pro forma” earnings will appear on the scene. The TBTF bank CEOs will rightly blame Washington.
Bernanke has bankers believing interest rates will never be normal again. However, bankers have been surprised before.