The inversion of the yield curve — the market indicator that has rattled Wall Street — has had a particularly pronounced effect on US regional banks, whose shares are among the worst performers of the past few weeks.
So-called asset sensitive banks, those with a business heavily weighted towards floating-rate loans such as to businesses, face a hit to their profits because of the slump in yields, which pulls down the interest they will receive.
Another result: in some cases, their shares appear to have started trading in lockstep with changes in the yield curve.
“The moves up and down on a daily basis [in response to] the curve have been so violent and so quick that I’m not sure it is traditional asset managers that are causing this,” said Anton Schutz, who manages a portfolio of small-cap bank stocks at Mendon Capital.
He suspects that macro hedge funds and algorithmic traders have the banks in their sights. “Machines are trading this,” he said.
The yield curve describes the yields on different maturities of US government debt, and its inversion — when rates on long-term bonds fall below those on short-term debt — has been a reliable indicator of recessions in the past.
It also makes it much harder for asset sensitive banks to make money, since they cannot offset falling income from floating rate loans by cutting the rates they pay depositors, since these are already at rock bottom. Larger banks can have other fee-based businesses such as wealth management or payments that make their profits less sensitive to the yield curve.
Shares in institutions including Silicon Valley Bank, Comerica and Citizens, Wall Street darlings just a year or two ago, have traded in lockstep with the change in the relationship between three-month Treasury bills and the 10-year note.
That relationship first inverted in March, meaning the three-month offered a higher rate of interest, and has been consistently and ever more deeply negative since May. At the close on Friday, the 10-year was yielding 32 basis points less than three-month bills.
Silicon Valley Bank is one of the hottest growth stories in the industry. It specialises in serving young tech companies, and has a deep base of non-interest bearing deposits, as start-ups hold their venture financing or IPO proceeds with the bank. The asset side of the balance sheet is dominated by floating-rate business loans.
Comerica is similarly fast growing, and concentrated in corporate deposits and lending. Shares in both banks tripled between 2016 and 2018, while the yield curve was broadly stable, but have sold off since late last year, as prospects for Federal Reserve rate rises have dimmed.
Other banks that have fallen into line with the fluctuations in the curve include Zion Bancorp, Regions Bank, Bank OZK, and People’s United.
Bank investors and executives argue that opportunistic traders are overlooking the asset-sensitive banks’ capacity to adjust their balance sheets and increase profits despite an inverted yield curve.
Bruce Van Saun, chief executive at Citizens, whose shares have tumbled 14 per cent since late July, said that while the bank has a high concentration of floating-rate assets on its balance sheet, lending margin is not the only contributor to earnings growth.
“Fee growth is positive, expense control is positive, and credit [quality] is positive . . . three out of four profit [drivers] are working — so we can hang in there and have a good year.”
Citizens, like many other banks, has been adding interest-rate hedges to limit the impact of further declines in short-term rates. In addition, Mr Van Saun said, “we should see an offset, in terms of loan demand” increasing as rates come down. “We are already seeing it in mortgages.”