Before getting into stage 3 of the impact of a Fed rate hike on the money centers, which involves the mortgage and housing industries and will require a few columns to address, I'm going to discuss the relationship between the first and second stages and expand on some issues I did not discuss substantively in those columns.
In stage 1, the banks are afforded the opportunity to raise the interest rates charged consumers on loans that have adjustable rates, predominantly credit cards and home equity loans.
The impact of this is immediate and will be evident in the 2016 first quarter's 10Q's filed with the SEC and more detailed in the quarterly Reports of Condition and Income (call reports).
In general, this is positive for bank revenue and earnings to the degree referenced in the earlier column but has little value as an indicator of economic or capital market activity.
In stage 2, the rates on maturing short-term loans, predominantly in the commercial and industrial (C&I) loan space, begin to be adjusted up for the new refinanced period, if the borrower chooses to do so. This process will phase in over years as the terms are usually three to seven years.
The two most important areas of concern within the C&I loans is the debt attributable to the alternative oil exploration and production (E&P) sector, which I addressed in the column, "The Biggest Current Threat to the Markets," and the loans for carry trades, which I addressed in the column, "Fed Rate Hike Could Spur Carry Trade Closings."
The alternative oil E&P companies discussed in the first column have experienced a decline in stock prices of between 2% and 20% in the past month as the prospect for higher debt carry costs caused by an increasing Fed funds rate are magnified by the downward pressure on oil prices that occurs as a result of a Fed rate hike as well.
On the carry trade issue, the crash in equity values at the end of August is instructive as it occurred commensurately with a 90% reduction in C&I loan growth during the third quarter. It is probable that a substantial portion of the equity selloff was caused by CFOs closing out carry trades funded with C&I loans.
I expect this process accelerated during 4Q and will be evidenced as a contraction in C&I loans carried by the money centers when the 4Q call report data are available in mid-February.
Whereas the immediate increase in rates charged on adjustable rate loans to consumers provides a push to bank revenues and earnings, the deceleration, and probable contraction, in C&I loans to corporations commensurate with an increase in delinquencies and defaults will provide an opposing drag on revenue and earnings.
Additionally, unlike the credit card and home equity loans, this activity is part of capital market activity and is indicative of near-term economic potential.
This also leads into the third stage of the impact of a Fed rate hike, and switches back to a focus on the consumer, which is the impact on mortgage rates, housing activity and overall consumer confidence.
As pertains to the money centers, the most important aspect of this is the surge in home mortgage originations by JPMorgan (JPM) during the past three years, inclusive of this year's third quarter, as it has challenged Wells Fargo's (WFC) dominance of the industry. (Wells Fargo is part of TheStreet's Action Alerts PLUS portfolio.)
In 3Q, Morgan's first trust residential mortgage book increased by about 9%, from $170 billion to about $185 billion. In comparison, Wells' was unchanged. This is partially due to Wells' increasing focus on diversifying its loan book so that it's not so concentrated in mortgages but more importantly because of the aggressive challenge coming from Morgan.
This situation, combined with the lack of ability to capitalize on a Fed rate hike because of the low percentage of carried loans that are tied to adjustable rates, the decrease in C&I loan originations and the fact that it is losing mortgage share to the non-bank mortgage companies, especially first-time homebuyers, is setting Wells up for a potential crisis early next year.
Wells' primary business has been the jumbo and non-agency residential mortgage sector, which it dominated until Morgan began challenging it over the past few years.
Its primary means of offsetting the business lost in that sector has been to increase auto loans, which at about 6.5% of all loans is the highest percentage of all the money centers.
That business has probably peaked, though.
I'll discuss the totality of how the housing and mortgage industry will impact the money centers next week, but the bottom line is that Wells is the one with the most downside risk.