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  1. Home
  2. / Investing
  3. / Financial Services

Fed Is Getting Annoyed With Banks

They keep giving out low-cost commercial and industrial loans.
By ROGER ARNOLD May 07, 2015 | 03:00 PM EDT
Stocks quotes in this article: USB, COF, PNC, TD, STI, BBT, MS, CFG, FITB, RF, MTU, MTB, NTRS, BK, IAT, KBWB, KRS, KRS

The growing vocal concerns by central bankers globally concerning financial stability, which I wrote about earlier this week, is an extension of the concerns about stock markets being supported by way of carry trades being put on and by share buybacks by companies. Both of these areas have been largely funded by banks making commercial and industrial (C&I) loans to borrowers for such purposes.

What has annoyed central bankers is that the viability of using C&I loans for carry trades and financial engineering was made possible by their very low rates of interest, which is a result of monetary policy, and that this is not the central banks' primary intended purpose for the low-cost debt capital.

What has annoyed the central bankers further, especially at the Fed, is that they've telegraphed the trajectory for their plan and timeline to begin raising rates from the time they began to implement QE3 in September 2012. The point of doing so was to provide banks and borrowers with a long lead time to begin to decrease the use of carry trades and at least begin the process of unwinding them before the Fed began to raise rates.

But this has not happened. Instead of decreasing the rate of carries being put on and slowly unwinding them, banks and borrowers have increasingly put them on, even over the past six months as the Fed has been increasingly vocal about its intention to raise rates.

This process has been most exaggerated in the national and super-regional banks in the U.S., with the greatest concentration being in the 17 largest banks other than the top four money centers. That group consists of all banks that have assets of $100 billion to $999 billion.

Of them, 14 are publicly traded in the U.S. and three are branches of foreign banks. Of the 14 U.S.-traded banks, I've deleted Bank of New York Mellon (BK) from consideration here because of its unique status within the banking system, which I discussed two years ago in the column, "Digging In to Tri-Party Repos."

The remaining 13 listed in descending order based on total assets are; U.S. Bancorp (USB), Capital One (COF), PNC Financial Services Group (PNC), Toronto-Dominion Bank (TD), SunTrust Banks (STI), BB&T (BBT), Morgan Stanley (MS), Citizens Financial Group (CFG), Fifth Third Bancorp (FITB), Regions Financial (RF), Mitsubishi UFJ Financial Group (MTU), M&T Bank (MTB) and Northern Trust (NTRS).

The average percentage of loans allocated to C&I across the group is higher than all other banks either larger or smaller at about 25%. The average across all other banks is closer to 20%.

At seven of these, C&I loans are the largest asset class. At four, it's the second-largest class. The outliers are Capital One, where C&I is the fourth-largest asset class, and BB&T, where it's the third-largest.

At only two of them has there been a decrease of the percentage of loans allocated to C&I over the past three years. More importantly in the immediate is the fact that all 14 have increased the percentage of C&I loans they carry over the past six months, even as the Fed has been increasingly vocal about wanting to raise rates -- which is one of the reasons the Fed has been so vocal.

Investors appear to be somewhat aware of this issue, however, as the group has underperformed the money centers over the past five years, as is evidenced by the relative performance of the iShares US Regional Banks ETF (IAT) and PowerShares KBW Bank ETF (KBWB). IAT is the regional banks and KBWB is the regionals plus the money centers.

In the past five years, IAT is up 38%, whereas KBWB is up 88%.

In the last two years, however, both funds have risen in concert by about 28%, much of which is probably due to the increased reliance upon C&I loans by them all, but especially the regionals.

The closest inverse ETF for hedging/speculating purposes is the ProShares Short KBW Regional Banking (KRS).

The recent route in U.S. and German long-end sovereign debt commensurate with a selloff in all asset classes may be a sign that the process of deleveraging and closing out carry trades has begun. If that's true, it's probable that the sector that will be most impacted by such will be the national and super-regional banks.   

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At the time of publication, Arnold had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Financial Services | ETFs | Funds

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