The Federal Reserve's decision to keep rates at zero won't bruise banks, but it could force them to downshift their asset sensitivity.
Perhaps the most highly anticipated meeting ever of the Federal Open Market Committee passed Thursday with no change to the zero-rate policy of the past six and a half years. That is surely a disappointment to bankers who hoped for an end to years of margin compression, but it hardly means the sky is falling — banks can continue to survive and thrive without any rate relief.
But they will have to adapt, especially if, as hinted in the Fed's announcement, the timeline for rate increase is getting longer. Low rates could continue "for some time" even after inflation and unemployment are back to normal levels, the statement said.
The low rates also have a few silver linings. Mortgage lending could get a boost, and the spigot of cheap core deposits should stay open.
Cost cuts and furious efforts to fuel loan growth will likely continue to be banks' main strategies to boost earnings.
And the more rate-sensitive lenders may now have to start tilting their balance sheets to longer-term assets.
The damage from the zero-rate policy is "more psychological than actual," bank analyst Nancy Bush of NAB Research wrote earlier in the week.
FIG Partners last month estimated that less than half of all banks would have seen a bump up in net interest margin by the end of the year if the Fed had, as many expected, lifted rates by 25 basis points at the meeting Thursday.
Many floating-rate loans would have repriced instantly, but the net interest margin improvement would have been gradual.
"A small rate increase, which is what people are expecting to occur, isn't a huge deal but as rates move up over time that will be more impactful," said Allen Tischler, a banking analyst for Moody's, speaking before the Fed's announcement.
If bankers decide that Thursday's decision is a sign that the Fed will stand pat for months, then many of them will have to pore over their books.
"You might see a modest change in balance-sheet structure or balance-sheet strategy," said Christopher Wolfe, a Fitch Ratings analyst. "The very asset-sensitive banks may trim asset sensitivity by taking some short-term securities and going out a little further in the curve on securities book."
Wells Fargo had already been shifting to a less asset-sensitive mix before the Fed's announcement to become less dependent on interest rates, Chief Financial Officer John Shrewsberry said Wednesday at a conference in New York.
"We don't want to make short-term decisions that are going to have a negative long-term impact," he said. Wells has recently worked "to grow earning assets but to become less interest-rate sensitive."
The other takeaway from the Fed's decision is that the era of cheap deposits will continue. Nobody knows how deposit customers will respond to a rate rise, or how hard banks will compete to hang onto or gather new deposits once rates do rise, said Tischler.
"On the deposit side, the impact would come down to customer behavior and banks' competitive decisions," Tischler said. "The banks themselves disclose the effect rising rates would have on deposits, but the impact is completely dependent on how the scenarios are modeled."
That means the other half of the NIM equation — cost of funds — could respond unpredictably to a rate increase. In the last tightening cycle, from 2004 through 2006, the Fed's rate rose from 1% to more than 5%, but average NIM contracted because the yield curve flattened, said Fitch banking analyst Bain Rumohr.
There would have to be "a more material rate rise than 25 basis points and, along with that, a steep yield curve" for banks' NIMs to benefit, he said.
Other analysts expect deposits to remain easy to come by even once the Fed raises rates. Bush wrote that, based on her talks with banks of all sizes, "one thing was very, very clear — bankers everywhere, of all sizes, do not see an end to the tsunami of consumer and corporate deposits that continue to flow through America's banks," she said.
So the biggest letdown from the Fed's failure to raise is likely to be on bank stocks. Many analysts have baked rate rises into their estimates of bank earnings, and with any rise now looking to be later and more gradual than expected before, shares could suffer.
Keefe, Bruyette & Woods, for instance, calculated earnings estimates for bank stocks with assumption that rates would rise as much as 1.25% by the end of next year, it said in research published last week. A slower rate increase — 25 to 50 basis points over that time frame — would reduce bank earnings by 1.7% from their baseline estimates by the end of 2017.
But like many forecasts, that rate estimate is now likely to be revised following the Fed's actions. And banks, like analysts, are likely to closely read the Fed's statements for any hint of when its low-rate policy can change.
In other words, the frantic speculation and uncertainty about Fed's policies is likely to continue until a rate rise finally begins.
"We're looking into uncharted territory on Fed policy," said Wolfe, the Fitch analyst. "We can't look in the rearview to divine what's going to happen."
Chris Cumming is a reporter at American Banker.
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