A Fed rate cut could wreck bank earnings - here's why
If the Federal Reserve cuts the benchmark federal funds rate this year – and traders are increasingly betting the U.S. central bank will do so – it could have a negative impact on banks, and their quarterly earnings.
A recently published Bank of America Merrill Lynch investor note found that if the U.S. central bank lowers the benchmark federal funds rate by 75 basis points to 1.5 percent to 1.75 percent by early 2020, it would reduce large-cap bank earnings by up to 10 percent. The current rate range is 2.25 percent to 2.5 percent.
“Lower short-term rates are expected to negatively impact bank earnings,” Erika Najarian, research analyst at Bank of America, said in the note.
Lower interest rates can hurt a bank’s profitability because borrowing costs directly increase the cash yield, which goes into the company’s earnings. When interest rates rise, the spread between the yield they generate with cash invested in short-term notes and the cash they pay out to customers increases; however, if the Fed cuts rates, that spread is expected to flatten.
Traders are increasingly forecasting at least one Fed rate cut this year, with about 66.7 percent pricing in a cut by the FOMC’s July meeting.
If the Fed drops the interbank lending rate, Najarian said, JPMorgan Chase’s earnings could be cut by 10 percent. Comparatively, in April, JPMorgan reported record first-quarter profit that it said was buoyed, in part, by higher interest rates, with net interest income climbing 8 percent to $14.60 billion.
| Ticker | Security | Last | Change | Change % |
|---|---|---|---|---|
| JPM | JPMORGAN CHASE & CO. | 249.72 | -0.07 | -0.03% |
| CFG | CITIZENS FINANCIAL GROUP INC. (RHODE ISLAND) | 48.14 | -0.02 | -0.04% |
| MTB | M&T BANK CORP. | 219.99 | -0.81 | -0.37% |
| C | CITIGROUP INC. | 70.87 | +0.71 | +1.01% |
| SBNY | SIGNATURE BANK (NEW YORK NEW YORK) | 1.23 | +0.03 | +2.50% |
And, regional bank earnings could take an even bigger hit than JPMorgan.
According to the research note, Citizens Financial’s profits could fall by 16 percent. M&T Bank Corporation’s earnings, meanwhile, could be reduced by 14 percent.
CLICK HERE TO GET THE FOX BUSINESS APP
Some banks, however, like Citigroup and Signature Bank could weather the rate-cut storm, thanks to above-average deposit costs and large percentages of money market accounts, Bank of America said.