Increased Interest Rates Erode Bank Capital
Shares are rocking, the President says there will be no recession and supposedly it's smooth sailing for banks. However, a report from the ground appeared in the latest Grant’s Interest Rate Observer. Joe Goyne, chairman of Pegasus Bank, Dallas, wholly owned by BancFirst Corp. passed on the following to Grant’s presumably about his competitors in Texas (but likely applies nationwide): Many banks are loaned up to 90 percent of their deposits. Many banks bought mortgage-backed securities during the zero-rate days to “juice income,” but now, on a mark-to-market basis those MBS are trading for a fraction of purchase prices, creating losses of 50 to 60 percent of capital. “Regulators are not pleased.”
Banks large and small were slow to increase deposit rates and are now trying to make-up ground “creating current margin compression even though the Fed keeps increasing rates.” Large savvy depositors are well aware they can receive 4 percent plus from short-term U.S. Treasuries and are negotiating for similar rates from high loan-to-deposit banks which absolutely, positively cannot afford any deposit runoff if they wish to stay open. “I think this last point will create some meaningful liquidity problems in some banks.”
Sounding a warning at the Economic Club of Washington, Fed chair Jerome Powell said, “The reality is if we continue to get strong labor market reports or higher inflation reports, it might be the case that we have to raise rates more [than previously anticipated].”
What might happen if Dominique Dwor-Frecaut, a senior market strategist at the research firm Macro Hive, is right? She says the Fed will have to hike the federal funds rate to about 8% to win its battle to bring inflation fully under control, Bloomberg reports.
“I’m even more confident about my 8% call after the nonfarm payrolls report,” Dwor-Frecaut, who previously worked in the New York Fed’s markets group, said in a telephone interview with Bloomberg, referring to surprisingly-strong employment data published on Feb. 3. “The funds rate has to go much higher than is now predicted. Policy is still very easy.”
“If I’m correct on inflation and the Fed’s policy rate, it’s going to be an enormous shock for the market,” Dwor-Frecaut said. “So, I see potential for much deeper inversion. Two-year yields will move much higher. Getting beyond 6% is easy.”
What would Dwor-Frecaut projected rates do to an MBS portfolio gathered during ZIRP? Regulators might go from “not pleased” to wrapping the highly leveraged in yellow tape on Fridays at closing time.
Could checking on the FDIC website on Friday’s for fresh failures become a thing again?
