Due to the Federal Reserve’s announcement to keep interest rates low until late 2014, more concerns are being raised in the financial industry. Banks such as Citigroup Inc. (NYSE:C) and Wells Fargo & Co. (NYSE:WFC) may find it more difficult to increase earnings and capital, as record low interest rates will keep a lid on the number of loans or securities with yields high enough to support their net interest margins. Net interest margins are one measure of profitability, representing the difference between the cost of funds and what they earn on assets.
The banking sector (NYSE:BKX) was the worst performer on Thursday, as the markets adjusted to the Fed’s announcement. “This hurts the banks, I don’t think there’s any question about that,” explained Ralph Cole, senior vice president of research at Ferguson Wellman Inc. “Their cost of funds stays low but it makes it harder to earn a return.” Shares of JP Morgan (NYSE:JPM) declined .32 percent, while Bank of America (NYSE:BAC) slid almost 1 percent. “As a bank investor, this is not a welcome response” from the Fed, said Peter Kovalski from Alpine Woods Capital. Bank stocks “have had a good run here, but they could give back some of the gains in the next few weeks.” Studying the Fed data, Bloomberg explains that the average net interest margin at the four largest U.S. banks dropped to 2.99 percent in the fourth quarter, representing a decrease from 3.17 percent in the previous year. Also, the margin at domestic banks with at least $15 billion in assets declined to 3.44 percent in Q3 2011, compared to 3.85 percent in the Q1 2010.
One of the hardest hit companies on Thursday was E-Trade Corp. (NASDAQ:ETFC), which experienced a 14.64 percent decline in share price. The online broker reported a surprise fourth quarter loss of $6.3 million. The company explained, “While fourth quarter results were lower than our expectations owing to a few line items, our reduced expectations for 2012-2013 owe more to a more meaningful contraction in our net interest margin outlook than we had previously estimated.” Goldman Sachs (NYSE:GS) also downgraded the company from buy to neutral because of net interest margin concerns.
As record low interest rates continue to linger on, banks are likely to continue to reduce expenses. Morgan Stanley (NYSE:MS) has placed a cap on cash bonuses and is awarding more bonuses through long-term stock options. Furthermore, Bloomberg reported that Bank of America is now freezing base salary levels and cash bonuses in an effort to preserve capital.
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