Further Quantitative Easing Will Harm JPMorgan, Others

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Never fear, the Federal Reserve is here to the rescue. The Fed recently announced that it will buy mortgage bonds and keep interest rates very low into 2015 and possibly beyond. Haven't we all seen this film before? Isn't the definition of idiocy itself, by no less than Albert Einstein, is to do the same thing over yet expect a different result? I am not one of those types to shill for smaller government, but who in his or her right mind really believes another, probably smaller round of quantitative easing will do anything except expend taxpayer money.

The Federal Reserve has the ability to exert significant influence on interest rates. But its actual powers to achieve actions that affect the economy are very limited beyond that one scope. Its monetary policies can and do impact inflation rates, of course. There were and are some undoubted benefits to having historical lows in both short term and long term interest rates, along with the overall stabilization that came with the original, roughly $900 billion TARP act. But then came two rounds of Twist operations, and a still roughly stagnant economy. There is precious little room for further lowering of interest rates, so what could the Federal Reserve be planning? From where I sit, the low interest rate environment that has now existed for several years has served to depress the incentive for banks to loan out money, and further flattening of the yield curve is just not going to do anything for Main Street.

One thought is to assure the market that there is a future in long-term loans. The quickest way the Federal Reserve can do that is to publicly declare an allowance for reasonable inflation in the overall economy. The other thought is that the Fed is going to dump another $500 billion into yet another quantitative easing program. The economic return for the latter would, in the Federal Reserve's own estimates, be scarcely large enough to notice.

All banks have suffered with interest margin contraction. For while it is nice that credit costs have fallen, interest revenue has generally fallen even further. Federal regulations such as the Durbin Amendment have negatively impacted non-interest income. Most banks have therefore suffered flat to negative revenue comparisons, and have resorted to reducing expenses to maintain earnings. The biggest banks are under even more pressure, given the prolonged inactivity in capital markets.
JPMorgan (NYSE: JPM) is a classic example of all these pressures.  Its net interest margin, which averaged 3.91% in 2009, has steadily fallen, virtually quarter by quarter, down to 3% in the second quarter of 2012. Of course, JPMorgan has more than its fair share of issues. Senator Carl Levin (D-MI) and his permanent Senate Subcommittee on Investigations has JPMorgan and its massive “London Whale” related trading losses squarely in its sight. Unlike many things in Washington, this historically patient and bipartisan committee may spend months hauling in to testify everyone who had a role in the trading loss. It promises to rival the same Committee's 2009 – 2010 investigation into the banking crisis, the blame for which the Committee laid at the feet of the large banks themselves.
The fact is, JPMorgan's underlying profits are solid. But no one at this time outside the company itself really knows what third quarter earnings will be due to continuing costs of its trading scandal. But some very interesting news from the summer was that this country's best known value investor, Warren Buffett, disclosed that he personally owned shares of JPMorgan. Buffett has long spoke glowingly of the bank and CEO Jamie Dimon. In disclosing his personal ownership, Buffett explained he found the JPMorgan more difficult to understand than banks, including Wells Fargo (NYSE: WFC) and M&T Bank (NYSE: MTB), that Berkshire Hathaway (BRK-A) does own.

While JPMorgan's interest margin has been squeezed, it still exceeds some of its direct competitors. Bank of America's (BAC) net interest margin in the second quarter was 2.21%, and Citigroup's (C) was 2.81%. But as with most bank measurements, some banks manage their margins better than other banks. U.S. Bancorp (USB) reported a net interest margin in the second quarter of 2012 at 3.58%. It has been trending down gently, at it stood at 3.67% in the second quarter of 2011. And Wells Fargo reported a net interest margin in the second quarter of 3.91%, down ten basis points from the 4.01% from the second quarter of 2011. All of these banks and others are reporting at the Barclays Capital Global Financial Services Conference in New York. I will be reporting on that conference in the days ahead.
All these net interest margin amounts were already under pressure as more higher interest commercial and mortgage loans are being repriced at today's lower rates. And the longer those rates stay at historically low levels, the higher the percentage of the banks' interest earning portfolios will be repriced.
But more important, this third round of quantitative easing may well do more harm than good. There is scant evidence that the last two rounds of easing gave substantial benefits to the economy. This third round is likely to produce even smaller returns, and the flow of cheap money into the economy eventually cause the sort of dollar devaluation and inflation that no one wants to see.
Interest margins are a key driver of bank profits. At least one bank, Hudson City Bancorp (NASDAQ: HCBK), essentially stopped writing loans because it could not operate its business model in such a flattened and low interest rate environment. This ended up with Hudson City's acquisition earlier this quarter by M&T Bank. If banks are essential tools for greasing the wheels of Main Street, further quantitative easing will almost surely put some sand in that grease.
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Posted in: Bank of America,JPMorgan,Nasdaq,NYSE,The Fed