The biggest U.S. banks are starting to stall after eye-popping runs that sent their stock prices soaring.
At this time last quarter, shares of Bank of America Corp. and Citigroup Inc. had skyrocketed about 75 per cent over the previous 12 months. The U.S. economy was picking up speed and investors finally had enough confidence to try their luck with bank stocks again.
Just three months later, the momentum has slowed. Since January the country's four biggest banks are up between 20 and 25 per cent each and the banks all face the same headwind: uncertainty about interest rates. Although the Federal Reserve is widely expected to keep its benchmark interest rate at 0.25 per cent for at least another year, longer term bond yields fluctuate daily, and they skyrocketed after the Fed announced in May that it would consider slowing the pace of its monthly bond purchases, which serves as a form of stimulus.
In theory, that should help banks because they make money by borrowing at cheaper short-term rates, and then lend that same money out at higher long-term rates. But the adjustment process is tough, and it could take multiple quarters for the banks to realize the benefits.
Banks rely on client deposits as a major source of funding, and the interest rate paid on deposits fluctuates with the market. Long-term loans, however, are often locked in at fixed rates, so banks can only re-price them when they come due.
"What happens generally is that your liabilities – your deposits – reprice faster than assets," Janice Fukakusa, Royal Bank of Canada's chief financial officer, said in an interview.
The sudden surge in longer-term rates also took an immediate hit on bank mortgage lending and re-financing, as homebuyers and homeowners suddenly reconsidered their actions.
"The back-up in long-term interest rates has wreaked havoc in the residential [refinancing] market, which will lead to plummeting 'refi' revenues and one-time charges associated with the downsizing of mortgage operations," noted Royal Bank of Canada analyst Gerard Cassidy.
The banks have already taken action, slashing 10,000 mortgage jobs between Bank of America, Citigroup, JPMorgan Chase & Co. and Wells Fargo & Co. this year.
The sudden rise in bond yields is also expected to serve as a shock to fixed-income trading revenues – and many banks have already warned that profits from these units will drop. Citigroup is expected to be one of the hardest hit, largely because it has a major bond trading department that brought in revenues of $14.5-billion (U.S.) over the past four quarters.