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September
27
2019

These bank stocks could be crushed if the Fed keeps lowering interest rates
Philip van Doorn

KBW paints a dire scenario for 20 U.S. financial-services companies

Under a scenario with long-term interest rates in the U.S. falling below zero, KBW’s 2021 earnings estimate for Charles Schwab would drop by 61%.

The Federal Reserve’s looser monetary policy doesn’t bode well for bank profits. And a new report from Keefe, Bruyette & Woods analyst Frederick Cannon paints a far uglier scenario if the U.S. moves closer to the negative-rate environment of other developed economies.

Cannon’s report was published Sept. 25 and included price-to-earnings (P/E) ratios based on KBW’s earnings estimates for 2021, and also another set of P/E ratios based on a scenario under which the federal funds rate moves to a range of 0% to 0.25% by the end of 2020 and the yield on 10-year U.S. Treasury Notes TMUBMUSD10Y, -0.66%  “goes negative” in the third quarter of 2020. 

While it may still seem far-fetched to have negative yields in the U.S., it’s important to keep in mind that the federal funds rate target was 0% to 0.25% for seven years through Dec. 16, 2015. We can easily go back there and if demand for U.S. dollars continues to be strong, negative yields on the 10-year bond may even be likely, unless a significantly strengthening economy forces the Fed to change direction again.

Cannon also analyzed another scenario that combines low rates with a recession. But in this article we are only looking at numbers drawn from the negative-rate scenario, leaving out a recession.

Negative interest rates would not only affect banks, they would also hurt most financial-services companies whose profits depend on the spread between what they pay for funding and what they earn on loans. Charles Schwab SCHW, +0.81%,  the pioneering discount broker that is technically a savings-and-loan holding company, is a prime example. The company announced this month that it would cut 600 jobs, with CEO Walt Bettinger citing the decline in interest rates. 

According to Schwab’s second-quarter income statement, net interest revenue totaled $1.61 billion, or 60% of total net revenue. Schwab’s shares trade for 16.2 times KBW’s current 2021 earnings-per-share estimate, but for 41.8 times the 2021 EPS estimate under the firm’s “negative-interest-rate scenario.” Under that scenario, KBW’s 2021 earnings estimate for Schwab drops 61% to a dollar a share from $2.58.

Here are the 20 financial-services companies in KBW’s coverage universe whose earnings estimates would decline the most under the firm’s negative-interest-rate scenario:

The much higher P/E ratios for many of these companies underline how dire the negative-interest-rate scenario could be. And these numbers don’t even reflect the possibility of a recession to go along with the negative rates.

Here’s the same data for the “big six” U.S. banks:

It’s fascinating to see that even under the negative-interest-rate scenario, the largest banks’ P/E valuations wouldn’t be much higher.

 

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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