Banks are suffering from low net interest margins
(NIM) and net income growth since the 2008 Great Recession. Some believe the
Federal Reserve’s low interest rate policy is responsible for this situation.
In fact, the two favorite excuses provided by banks for performance issues are
regulation and low rates. This post focuses on the bogus interest rate excuse.
Bankers are awaiting the long expected Fed rate hike now hoped for this fall.
They believe NIM, net income and hopefully stock prices will benefit from the
hike. NIM and net income may initially and temporarily improve but bank stock
prices are unlikely to improve.
All intrinsic valuation models capitalize expected future
earnings or cash flows and their timing at a discount rate. The rate reflects
two factors. The first is the time value of money (i.e. present value factor)
usually represented by the risk free (Rf)
rate of return. The second factor is the riskiness of the cash flows. Keeping risk,
earnings and the timing of the earnings constant, rate increases will impact
the time value of money thru changes in Rf. Simply stated expected earnings
discounted at a higher rate have a lower (present) value.
It gets a little more complicated for banks because there
may be an initial temporary increase in bank earnings when rates rise. This
depends on the shape of the yield
curve and how the bank’s balance sheet is positioned
(asset sensitivity). Over time, the liabilities will re price and the benefit
disappears.
All other things equal, rate increase are not good for
stocks, banks included. Simple valuation fundamentals may be forgotten, but do
not disappear.
J
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