Monday, 11 June 2012

Tom Brown’s Dire Outlook for Banking

Most market participants are understandably focused on immediate developments in the Euro-zone and the implications of the shell game being played over there for our domestic economy and markets. From my perspective, the perpetual kicking of the can down the road in Europe and the variations thereof here in the U.S. portend little more than an ongoing slow-motion train wreck for our global economy.

While central bankers try desperately to keep the train on the tracks, the easy money flowing into the system does not come without very real costs. Ask savers and individuals trying to live on a fixed income what a 0% Fed Funds rate does for them. Who else is being negatively impacted? The banking industry at large.
Really, how is that? 
Their NIM is getting squeezed. Their what? The net interest margin which represents the spread between the banks’ cost of funds and the returns generated on their asset base.
Top rated banking analyst Tom Brown offered a dire outlook for the banking industry this morning during a Bloomberg radio interview. Brown offered that in looking at the forward curve for interest rates, the market is projecting a 2% Fed Funds rate in 2020. From there, he projected under that interest rate scenario the banking industry will have shrunk by 25%!!
Wow. Talk about a dire outlook. In the current environment, with the overnight Fed Funds rate of 0% and a 10 Yr. U.S. Treasury benchmark rate of 1.6%, banks are getting squeezed in terms of generating positive spread. Adding fuel to this fire, with the outlook for the net interest margin in the banking industry not improving anytime soon, banks will be under real pressure to maintain their credit ratings. Potential downgrades will only put further pressure on banks. The large Wall Street banks without a consumer deposit base (Morgan Stanley especially but Goldman Sachs as well) are facing the prospects of a downgrade very soon.
A lower credit rating implies a higher cost of funds and a further squeezing of the net interest margin. The downward spiral, which is already well underway, will result in a contraction of the industry. What else will it likely mean?
I would project that those institutions with real influence — that is, the largest banks — will exert ever increasing pressure on their political cronies and ineffectual regulators to back off so they can generate revenues and further solidify their position within a contracting industry. The Wall Street oligopoly will likely gain even greater market share. This is not good. What does this mean?
Consumers and investors should be ever more vigilant for predatory practices. Developing personal relationships with individual bankers and advisors whom you fully vet and thoroughly trust is already important but will be even more so in the future.
Navigate accordingly.
Larry Doyle

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