The 10-year treasury yield fell to 1.367% on Tuesday, the lowest ever. At the same time, the difference between yields on the two-year and 10-year notes fell Tuesday to about 0.81 percentage point, its lowest level in more than eight years. The continuing downward march in yields is expected to render lending less profitable and drive down the income from securities that banks hold.
Second-quarter bank results won’t fully reflect the declines since the biggest drop happened after the UK’s vote to leave the European Union on June 23. But yields already had begun trending down in late May.
JP Morgan kicks off bank-earnings season on July 14.
For now, the decline in long-term rates has occurred without a corresponding drop in short-term interest rates, a phenomenon known as the flattening of the yield curve. Bankers say such circumstances can be as detrimental to earnings as the very low interest rates they have been grappling with for some time.
“This bank cares as much about the yield curve as we do about interest rates themselves,” Richard Davis, chief executive of US Bancorp, said last month. “There just isn’t another scenario that can be more challenging for banks,” he said, referring to the combination of slow growth, infrequent rate increases and a flattening curve.
Falling long-term yields mean banks earn less on loans whose rates are tied to such measures, such as mortgages. It also means certain securities banks hold will reprice at lower rates when they mature. Overall, the drop in long-term yields could drag down bank profits by 2%, Vining Sparks IBG analyst Marty Mosby estimates.
All this is likely to again pressure bank net-interest margins, a key metric of lending profitability representing the difference between what a bank pays to depositors and earns on lending and investing.
This margin has been under pressure for the past few years as the Fed and other central banks kept interest rates at near-zero levels and undertook extraordinary monetary policy such as buying bonds. The pressure seemed to be easing after the Fed in December raised short-term rates by 0.25 percentage point and looked poised to follow with more increases.
That now looks short-lived: Davis of US Bank, for instance, in June said falling long-term rates meant the margin was set to decline at the bank in the second quarter.
The increasingly gloomy environment for banks has led to a selloff of their stocks. The KBW Nasdaq Bank index has lost more than 9% since the UK’s Brexit vote last month. Some regional banks thought to be particularly dependent on rate increases have seen even steeper declines: shares in Regions Financial Corp. and Citizens Financial Group have declined about 15%.
Some lenders already have projected that such a rate environment will lead to multimillion-dollar profit declines. Birmingham, Alanta-based Regions said in a securities filing that it would expect annual profits from interest to drop about $ 65 million if long-term rates immediately fell 0.50 percentage point; the 10-year yield has now fallen about 0.40 point since the end of the first quarter. The potential profit decline equals about 2% of the $ 3.3 billion of profits from interest the bank reported in 2015.
Pittsburgh-based PNC Financial Services Group has forecast a yield curve that flattens by 1 percentage point would dent interest-related profits by nearly 2% over a year.
Still, some say the pain from the flattening curve may be manageable.
Mosby, who projected earnings pressure from the flatter curve, also said last week the strain was “less than you might think” because many bank loans and investments are tied to short-term rates.
There also is the prospect that an uptick in mortgage lending from borrowers drawn to low rates will be a bright spot for bank profits.
Write to Rachel Louise Ensign at email@example.com
This article was published by The Wall Street Journal