These bank stocks could be crushed if the Fed keeps lowering interest rates

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












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 “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












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 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:

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:

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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