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, -2.20% “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, -2.20%, 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:
| Company | Ticker | Closing price - Sept. 25 | KBW's current 2021 EPS estimate | KBW's 2021 EPS estimate under negative-interest-rate scenario | KBW's 2021 EPS estimate decline under negative-interest-rate scenario | P/E - current 2021 EPS estimate | P/E - scenario 2021 EPS estimate |
| Charles Schwab Corp. | SCHW, -2.20% | $41.80 | $2.58 | $1.00 | 61.2% | 16.2 | 41.8 |
| E-TRADE Financial Corp. | ETFC, -4.81% | $44.12 | $3.90 | $1.85 | 52.6% | 11.3 | 23.8 |
| SVB Financial Group | SIVB, -3.74% | $214.05 | $17.00 | $10.50 | 38.2% | 12.6 | 20.4 |
| CIT Group Inc. | CIT, -0.99% | $45.68 | $5.01 | $3.12 | 37.7% | 9.1 | 14.6 |
| TriState Capital Holdings Inc. | TSC, -2.76% | $21.71 | $2.16 | $1.35 | 37.5% | 10.1 | 16.1 |
| ProAssurance Corp. | PRA, -0.21% | $40.67 | $0.79 | $0.51 | 35.4% | 51.5 | 79.7 |
| Interactive Brokers Group Inc. Class A | IBKR, -0.54% | $51.73 | $2.42 | $1.56 | 35.5% | 21.4 | 33.2 |
| Comerica Inc. | CMA, -0.79% | $65.50 | $6.98 | $4.59 | 34.2% | 9.4 | 14.3 |
| Zions BanCorp. N.A. | ZION, -0.92% | $44.37 | $4.40 | $3.09 | 29.8% | 10.1 | 14.4 |
| M&T Bank Corp. | MTB, -0.21% | $157.24 | $14.63 | $10.36 | 29.2% | 10.7 | 15.2 |
| Citizens Financial Group Inc. | CFG, -1.24% | $35.60 | $4.05 | $2.90 | 28.4% | 8.8 | 12.3 |
| Metropolitan Bank Holding Corp. | MCB, -0.10% | $40.82 | $5.26 | $3.80 | 27.8% | 7.8 | 10.7 |
| Amalgamated Bank | AMAL, -0.37% | $16.16 | $1.60 | $1.16 | 27.5% | 10.1 | 13.9 |
| Fifth Third Bancorp | FITB, -0.98% | $27.66 | $3.24 | $2.35 | 27.5% | 8.5 | 11.8 |
| East West Bancorp Inc. | EWBC, -2.96% | $45.60 | $4.60 | $3.40 | 26.1% | 9.9 | 13.4 |
| Western Alliance Bancorp | WAL, -1.81% | $46.53 | $4.45 | $3.30 | 25.8% | 10.5 | 14.1 |
| Huntington Bancshares Inc. | HBAN, -0.80% | $14.37 | $1.28 | $0.95 | 25.8% | 11.2 | 15.1 |
| UMB Financial Corp. | UMBF, -1.67% | $65.82 | $4.25 | $3.20 | 24.7% | 15.5 | 20.6 |
| Wintrust Financial Corp. | WTFC, -1.72% | $65.61 | $6.05 | $4.55 | 24.8% | 10.8 | 14.4 |
| Provident Financial Services Inc. | PFS, -2.10% | $25.22 | $1.59 | $1.20 | 24.5% | 15.9 | 21.0 |
| Sources: Keefe, Bruyette & Woods, FactSet | |||||||
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:
| Company | Ticker | Closing price - Sept. 25 | KBW's current 2021 EPS estimate | KBW's 2021 EPS estimate under negative-interest-rate scenario | KBW's 2021 EPS estimate decline under negative-interest-rate scenario | P/E - current 2021 EPS estimate | P/E - scenario 2021 EPS estimate |
| J.P. Morgan Chase & Co. | JPM, -0.80% | $118.00 | $10.70 | $9.83 | 8.1% | 11.0 | 12.0 |
| Bank of America Corp. | BAC, -0.41% | $29.25 | $3.08 | $2.75 | 10.7% | 9.5 | 10.6 |
| Citigroup Inc. | C, -0.39% | $69.38 | $8.40 | $7.75 | 7.7% | 8.3 | 9.0 |
| Wells Fargo & Co. | WFC, -0.81% | $49.26 | $4.40 | $3.94 | 10.5% | 11.2 | 12.5 |
| Goldman Sachs Group Inc. | GS, -0.84% | $210.03 | $25.75 | $25.39 | 1.4% | 8.2 | 8.3 |
| Morgan Stanley | MS, -0.98% | $43.04 | $5.35 | $4.99 | 6.7% | 8.0 | 8.6 |
| Sources: Keefe, Bruyette & Woods, FactSet | |||||||
It’s fascinating to see that even under the negative-interest-rate scenario, the largest banks’ P/E valuations wouldn’t be much higher.
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