With the Fed on hold, banks' net interest margins continue to come under pressure. "The dramatic loan growth banks have enjoyed also will slow, especially in consumer- or mortgage-related segments," Bagley says. Another direct hit to earnings could come from the greater reserves banks set aside for rising defaults or credit deterioration. While big banks with thriving investment-%banking operations might hold up well, smaller regional lenders will have a harder time.
The KBW Bank Index has slipped 4% since March 21 even as the market advanced, as inflation stayed firmer than investors hoped. The index fell Wednesday after minutes from a recent policy meeting showed the Federal Reserve still vexed by inflation and none too likely to begin cutting interest rates soon.
The potential for economic deceleration, a worsening housing market and inflation that keeps the Fed's hands tied could prove to be a "perfect storm" for banks, says Dan Jones, who runs Blue Water Asset Management. As a hedge, he suggests buying June put spreads on the bank index.
This is not the most comforting news around. It's important to remember that banks are not invulnerable to a housing slowdown. The Streetlight Blog did a nice overview of the situation and came to this conclusion:
It may indeed be the case that banks will dodge any incoming bullets from the growing number of mortgage defaults, as many people argue. But evidence like this tells me that banks have a lot to lose if mortgages go bad.
Here are the links to the articles.