GLOBAL I RESEARCH CFA Society Maine The 2015 Outlook for Banks Stocks March 2, 2015 Corporation Gerard Cassidy (Analyst) (207) 780-1554 gerard.cassidy@rbccm.com Steven Duong (Associate) (207) 780-1554 steven.duong@rbccm.com John Hearn (Associate) (207) 780-1554 john.hearn@rbccm.com This report is priced as of market close February 26, 2015 EST. All values in U.S. dollars unless otherwise noted. For required Conflicts Disclosures, please see page 21
U.S. Labor Market & Unemployment JOLTS Data / Unemployment Rates 6,000 Quits, Mar-07, 2,985 5,000 4,000 3,000 2,000 1,000 Openings, Apr-07, 4,534 JOLTS Data JOLTS data measures job openings and labor turnover. Key items to focus on are the number of hires, openings, and quits. - 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Hires, Openings, Separations per Month (000s) Layoffs & Discharges Quits Other Separations Recessions Hires Openings Source: U.S. Bureau of Labor Statistics Data as of Dec-14 Unemployment Rates The U-3 is the official reported unemployment rate, which stood at 5.7% in January. The U-6 unemployment rate includes marginally attached workers and those working part-time for economic reasons. The U-3/U-6 spread measures the level of marginally attached workers and those working part-time for economic reasons. U-3 and U-6 Unemployment Rates (%) 18.0 8.0 16.0 7.0 14.0 6.0 12.0 5.0 10.0 4.0 8.0 3.0 6.0 4.0 2.0 2.0 1.0 - - Jan-94 May-95 Sep-96 Jan-98 May-99 Sep-00 Jan-02 May-03 Sep-04 Jan-06 May-07 Sep-08 Jan-10 May-11 Sep-12 Jan-14 U-6/U-3 Spread Unemployment Rate (U-3) U-6 Rate Source: Bureau of Labor Statistics U-6/U-3 Spread (%) Employment Outlook Looks Robust 2
U.S. Economy Private Residential Investment as a Percentage of GDP / U.S. Energy Production 8.0 7.0 (%) 6.0 5.0 4.0 3.0 1Q'67: 3.48% 2Q'70: 3.87% 1Q'75: 3.78% 3Q'82: 3.22% Historical Average: 4.68% 1Q'91: 3.47% 4Q'14: 3.26% Private Residential Investment as % of GDP Private residential has contributed ~4.70% to GDP on average. The latest reading came in at 3.26%, still below the pre-crisis troughs. 2.0 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 Source: U.S. Bureau of Economic Analysis mmbbl/d 12 U.S. Energy Production U.S. energy production is at the highest levels in almost 30 years, driven by onshore production. U.S. oil production five years ago was less than 5 million barrels a day versus over 8.5 million a day today. Onshore Lower 48 Housing Recovery Still Has Legs but Recent Oil Price Decline Could Slow Energy Production 11 10 9 8 7 6 5 4 3 2 NGLs Offshore 1 Alaska 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Source: U.S. Energy Information Administration 3
Loans and Leases of U.S. Commercial Banks 8,000 7,000 6,000 5,000 4,000 3,000 Current $7,999.6Billion Peak $7,323 Billion Loans and Leases of U.S. Commercial Banks Current loans and leases of commercial banks are at $8.0 trillion. Growth in commercial real estate and consumer loans is expected accelerate in 2015. 2,000 1,000-1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 ($ Billions) Total Loans & Leases Peak 10/22/08 to 3/24/10: -8.58% FAS 166/167 Trough 3/30/11 to current: 18.51% Other Real Estate C & I Loans Consume Home Equity Source: Federal Reserve board. Shaded areas indicate U.S. recessions. Data as of Feb 11, 2015 *Beginning 2/1/12, dataset includes thrifts that have converted to commercial bank charters. We estimate the impact to total loans to be $50.5 Billion. C&I Loans C&I loans have grown at a 10.5% CAGR since bottoming out in October 2010. The high level of growth has been driven in large part by a rebound in leverage lending. ($ Billions) 1,800 1,600 1,400 1,200 1,000 800 600 400 200-8.3% CAGR 7/80-8/90 9.3% CAGR 9/97-1/01-2.8% CAGR 8/90-12/93 14.8% CAGR 5/04-10/08-7.1% CAGR 1/01-5/04 10.5% CAGR 10/10-12/14-14.1% CAGR 10/08-10/10 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: Federal Reserve board. Shaded areas indicate U.S. recessions. Data as of Feb 11, 2015 *Beginning 2/1/12, dataset includes thrifts that have converted to commercial bank charters. We estimate the impact to total loans to be $50.5 Billion. Loans Outstanding at All-Time Record High; Loan Growth Expected to Accelerate in 2015 4
Household Debt 110.0% 100.0% 2009Q1: 104.1% 90.0% 80.0% 70.0% 60.0% 2014Q3: 79.1% Total Household Debt to Personal Income Total household debt stood at 79.1% in the fourth quarter, down from 104.1% in 1Q09. The deleveraging of the consumer balance sheet appears to be over. 50.0% 99:Q1 99:Q3 00:Q1 00:Q3 01:Q1 01:Q3 02:Q1 02:Q3 03:Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q1 08:Q3 09:Q1 09:Q3 10:Q1 10:Q3 11:Q1 11:Q3 12:Q1 12:Q3 13:Q1 13:Q3 14:Q1 14:Q3 Source: FRBNY Consumer Credit Panel/Equifax; U.S. Department of Commerce: Bureau of Economic Analysis. Beginning in 2003Q1, student loans are included in total household loans. 13.5 13.0 13.17% Q4-07 12.5 12.09% Q2-87 Household Debt Service as Percentage of DPI Household debt service to disposable personal income currently stands at 9.92% as compared to 13.17% in 4Q07. Lower interest rates have had a positive impact on consumer debt service. (%) 12.0 11.5 11.0 10.5 10.0 10.39% Q4-93 9.92% Q3-14 9.5 '80 '81 '82 '83 '85 '86 '87 '88 '90 '91 '92 '93 '95 '96 '97 '98 '00 '01 '02 '03 '05 '06 '07 '08 '10 '11 '12 '13 Source: Federal Reserve Board; shaded areas indicate U.S. recession Note: The household debt service burden is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt. Data as of Q3 2014. Household Debt Service and Total Debt Levels Remain Well Below Peak Levels 5
Subprime lending Subprime lending New subprime consumer loans increased to $189.3 billion in 2014. Auto loans represent the largest subprime consumer loan category at $129.5 billion of originations. Source: Equifax *Excludes home loans and student loans. Data are through November of each year and not adjusted for inflation. Subprime share of total mortgage originations.subprime mortgage lending remains anemic, however. Subprime mortgage originations have averaged ~$4 billion a year since 2009, down from a peak of $625 billion in 2005. Source: Inside mortgage finance Total mortgage originations include home-equity lending. Subprime Lending Driven by Auto Loans 6
Net interest margin/ Fed Balance Sheet Net Interest Margin (%) 4.50 4.25 4.00 3.75 3.50 3.25 4.29 4.274.22 4.08 4.06 4.08 3.94 3.90 3.83 3.81 3.60 3.62 3.55 3.52 3.39 3.42 3.35 3.253.25 3.253.26 3.21 3.143.133.123.12 Net Interest Margin Net interest margins (NIMs) have contracted to its lowest level in 30 years due to the prolonged low interest rate environment. NIMs are expected to stabilize in 2015 and increase as short-term interest rates rise in 2015. 3.00 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Annual 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 Quarterly Source: FDIC. 5.0 Total Factors Supplying Reserve Funds Assets on the Fed s balance sheet have risen from about $900 billion in 2006 to about $4.5 trillion today As a percentage of nominal GDP, Fed assets have grown from 6% of nominal GDP to about 26% of nominal GDP. The net expansion over this period primarily reflects the Fed s large-scale asset purchase programs. We expect it will take up to 10 years to bring the Fed s balance back to pre-crisis levels. Factors Supplying Reserve Funds ($T) Reserves & Factors Absorbing Reserve Funds ($T) 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 - (0.5) (1.0) (1.5) (2.0) (2.5) (3.0) (3.5) (4.0) (4.5) (5.0) Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Reserve Balance Other Deposits Other than Reserve Balance Treasury Cash Holdings Repo Currency in Circulation Other Treasury Currency Outstanding Gold Stock & SDR Central Bank Liquidity Swaps Maiden Lane Commercial Paper Funding Facility ABCP/MM Facility Broker/Dealer Facility TALF Direct Bank/AIG Lending Term Auction Credit Repo Agency & Debt Securities MBS US Treasuries Source: Federal Reserve NIMs are Expected to Stabilize in 2015 and Increase as Short-term Interest Rates Rise in 2015. 7
Credit Quality Nonperforming Assets and Net Charge-offs/ Loan Loss Reserves 3.5 6.0 NCO (%) 3.0 2.5 2.0 1.5 1.0 5.0 4.0 3.0 2.0 NPA (%) Nonperforming Assets and Net Charge-Offs Nonperforming assets continue to trend lower. Net charge-off rates trend lower as well and are near historical lows. Stronger for longer over next three years. 0.5 1.0-1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: FDIC Data as of 4Q14 Shaded areas indicate U.S. recessions NPAs NCOs - Loan Loss Reserves / Total Loans (1948-2013) 3.5% 2010, 3.31% 3.0% 1987, 2.73% Loan Loss Reserves Loan loss reserves peaked to an all-time high in 2010 at 3.31% of total loans and has fallen below the historical average to 1.48% of total loans at 4Q14. Loan loss reserves are expected to continue to trend lower into 2016. Loan Loss Reserves/Total Loans 2.5% 2.0% 1.5% 1.0% Average LLR/Lns, 1.78% 2006, 1.15% 3Q14, 1.54% 0.5% 1977, 0.92% 0.0% 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 Source: FDIC Recessions LLR/Lns Average LLR/Lns Credit Recovery Almost Complete and Credit Quality Expected to Remain Strong 8
Credit Quality 14.0 12.0 Delinquency % Total Loans 10.0 8.0 6.0 4.0 Delinquency Rates Delinquency rates continue to trend lower across all lending categories. Residential real estate delinquency rates remain elevated, however, at 6.63% in the 4Q14. 2.0-1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: FRB Data as of 4Q14 Res. RE CRE Total RE Consumer loans C&I loans Percentage of loans in foreclosure by state The rate of loans in foreclosure in judicial states remains elevated relative to the rate of loans in foreclosure in non-judicial states. The higher level of loans in foreclosure in judicial states has contributed to the relatively high delinquency rate of residential real estate. Source: Mortgage Bankers Association of America Delinquency Rates Expected to Continue Downward Trend 9
Energy Loans Large U.S. Banks Even under the worst case scenarios, large banks will be able to absorb losses from their energy exposures, in our view. For the largest banks in the U.S., we do not believe sustained low oil prices ($40-$45 a barrel) will have a material negative impact on them. Energy / Total Loans CRE / Total Loans CRE / Energy BOKF 20.1% 19.2% 95.5% CFR 16.1% 28.0% 174.1% GNBC 14.0% 18.8% 134.5% HBHC 12.0% 22.6% 188.3% ZION 8.0% 25.2% 314.5% CMA 7.0% 0.0% 0.0% PB 5.6% 32.8% 585.3% ASB 4.3% 17.2% 400.4% Source: SNL Financial LC; Energy Exposure Remains Manageable at the Largest U.S. Banks Banks with energy exposure We are concerned if oil prices remain depressed these banks will experience increased credit problems in both their energy and real estate portfolios. 10
Efficiency Ratio Efficiency Ratio Top 20 U.S. Commercial Banks Efficiency Ratio (%) Company Ticker 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 Chart 1 U.S. Bancorp USB 49.6 50.6 51.3 53.7 51.9 50.4 51.3 54.6 2 Capital One Financial Corporation COF 51.7 51.6 53.3 56.1 53.4 53.4 52.0 55.6 3 BB&T Corporation BBT 56.0 57.8 60.5 60.1 59.5 61.4 59.9 57.3 4 M&T Bank Corporation MTB 55.7 50.8 55.8 65.1 63.7 59.2 59.5 58.8 5 Wells Fargo & Company WFC 57.4 56.5 59.2 59.2 59.3 58.1 59.1 59.1 6 Fifth Third Bancorp FITB 61.1 63.5 62.3 64.2 62.9 64.1 59.6 61.1 7 SunTrust Banks, Inc. STI 64.2 65.4 70.6 65.8 66.5 63.5 61.4 61.8 8 KeyCorp KEY 67.0 68.5 66.9 69.0 67.2 67.9 68.1 63.8 9 Huntington Bancshares Incorporated HBAN 62.6 64.2 65.8 61.8 62.6 62.3 61.9 64.1 10 Comerica Incorporated CMA 66.7 64.5 65.3 73.3 65.9 64.5 63.4 64.9 11 PNC Financial Services Group, Inc. PNC 58.8 60.2 61.8 61.7 58.5 59.4 59.8 65.0 12 Citizens Financial Group, Inc. CFG 72.0 71.4 69.8 70.0 70.4 73.4 67.9 66.9 13 Northern Trust Corporation NTRS 72.5 70.5 71.8 73.0 72.5 74.1 70.9 68.6 14 State Street Corporation STT 71.4 67.0 67.7 71.1 77.1 67.3 69.3 69.0 15 JPMorgan Chase & Co. JPM 61.4 63.8 103.0 72.0 63.6 62.8 64.8 69.1 16 Bank of New York Mellon Corporation BK 76.4 71.8 72.2 73.9 73.1 73.7 74.4 72.5 17 Zions Bancorporation ZION 71.5 72.1 67.4 74.7 74.7 75.1 79.0 72.8 18 Bank of America Corporation BAC 69.7 66.2 81.1 81.2 85.9 82.8 70.8 73.5 19 Regions Financial Corporation RF 63.7 66.4 66.3 62.8 63.0 63.2 61.6 75.3 20 Citigroup Inc. C 62.1 60.4 66.5 69.1 60.7 61.3 66.5 82.0 Min 49.6 50.6 51.3 53.7 51.9 50.4 51.3 54.6 Max 76.4 72.1 103.0 81.2 85.9 82.8 79.0 82.0 Median 63.1 64.3 66.4 67.4 63.6 63.3 62.6 64.9 Average 63.6 63.2 66.9 66.9 65.6 64.9 64.1 65.8 Source: SNL Financial LC; Efficiency Ratio Efficiency ratios for the top 20 banks have hovered ~63-66%. Improved expense discipline have been offset by weak revenues and higher regulatory/operating expenses. Growth in revenues in 2015 is expected to help drive the efficiency ratios lower. Efficiency Ratios are Expected to Fall as Revenue Growth Picks-up 11
Basel III Common Equity Tier 1 (CET1) Ratio and Excess Capital Basel III CET1 Ratio and Excess Capital for Top 15 Banks Based on Latest U.S. GSIB Rules Basel III CET 1 Recent U.S. GSIB rules are more stringent than GSIB rules proposed by the BCBS. For some institutions, it effectively nearly doubles their capital surcharge (i.e. SIFI buffer ) under the BCBS rules. In $M except percentages Fully Phased-In Basel III at 4Q14 Expected B3 B3 CET1 CET1 Ratio Excess / (Shortfall) Company Ticker B3 RWA B3 CET1 Ratio Run-Rate % Amount JPMorgan Chase & Co. JPM 1,625,000 165,000 10.2% 12.0% (1.8%) (30,000) Bank of America Corporation BAC 1,465,633 141,274 9.6% 9.5% 0.1% 2,039 Citigroup Inc. C 1,299,000 136,541 10.5% 11.5% (1.0%) (12,844) Wells Fargo & Company WFC 1,312,800 137,000 10.4% 9.0% 1.4% 18,848 U.S. Bancorp USB 328,508 29,668 9.0% 8.5% 0.5% 1,745 Bank of New York Mellon Corporation BK 162,030 16,529 10.2% 8.5% 1.7% 2,756 PNC Financial Services Group, Inc. PNC 299,360 29,817 10.0% 8.5% 1.5% 4,371 Capital One Financial Corporation 1 COF 237,587 29,534 12.4% 8.5% 3.9% 9,339 State Street Corporation STT 107,829 13,525 12.5% 8.5% 4.0% 4,360 BB&T Corporation BBT 149,316 15,323 10.3% 8.5% 1.8% 2,631 SunTrust Banks, Inc. STI 160,400 15,600 9.7% 8.5% 1.2% 1,966 Fifth Third Bancorp 1 FITB 121,068 11,368 9.4% 8.5% 0.9% 1,077 Citizens Financial Group, Inc. CFG 108,846 13,173 12.1% 8.5% 3.6% 3,921 Regions Financial Corporation RF 101,997 11,315 11.1% 8.5% 2.6% 2,645 Northern Trust Corporation 1 NTRS 62,897 7,813 12.4% 8.5% 3.9% 2,467 1) On a transitional (not fully phased-in) basis. Source: Company reports; Capital Levels for the Industry are at Levels not Seen Since the 1930s 12
Future Profitability Future Return on Average Assets / Return on Average Common Equity 1.35% 1.30% 1.25% 1.20% 1.15% 1.10% 1.30% 0.03% 0.04% 0.08% 0.04% 0.02% 0.03% Future Return on Average Assets Return on average assets have been impacted primarily from new legislation and regulation. We do not expect ROAs to return pre-crisis levels. 0.03% 1.05% 0.00% 1.02% 1.00% Source: SNL Financial, LC;. 16% 15% 15.54% 0.36% 0.48% 0.94% Future Return on Average Common Equity Return on average common equity have been impacted by new regulatory capital requirements. We do not expect ROEs to return to pre-crisis levels. 14% 13% 12% 11% 10% 9% 0.50% 0.25% 0.38% 0.38% 2.04% 10.21% Source: SNL Financial, LC;. The Pre-Crisis Profitability Levels are Not Expected to Return 13
Future Profitability and Valuations Future Profitability and Valuations Lower profitability will drive lower valuations. L-T Valuations Should Benefit from Lower Stock Betas Average 1997-2006 4Q14 2015E - 2016E Return on Average Assets 1.30% 0.89% 1.00% - 1.10% Return on Average Common Equity 15.54% 8.40% 10.00% - 12.00% Price to Book Value (x) 2.37 1.20 1.25-1.50 Price to Tangible Book Value (x) 3.02 1.59 1.50-2.00 Price to Forward Earnings (x) 15.5 13.0 10.0-11.0 Relative Price to Earnings 76% 78% 60% - 70% Tier 1 Common Capital Ratio 1 8.29% 11.00% 8.00% - 10.00% Tier 1 Capital Ratio 9.49% 12.40% 10.00% - 12.00% Source: SNL Financial LC, Factset. Estimates are estimates. 1) Tier 1 Common Capital Ratio averages not available for 1997-2002. Average for period 2003-2006 used as approximation. Note: Averages are based on median values of each period, and top 50 banks are the top 50 in assets publicly traded commercial banks for each respective period. Lower Valuation Levels Are Likely in Near Term; Lower Betas Could Lead to Higher L-T Valuations 14
S&P500 Banks Price/Earnings Performance 19.0x 17.0x 15.0x 13.0x 11.0x 9.0x July 1987 - September 1987 data off chart March 2009 - March 2010 data off chart +1σ, 14.1 μ, 10.4 S&P Bank Index Absolute P/E Forward 12-Month Earnings S&P 500 banks have approached their historical mean price/earnings ratio. Stocks look fairly values on this measure. On a normalized earnings basis this ratio would be below long term average, in our opinion. 7.0x -1σ, 6.8 5.0x 3.0x 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 S&P 500 Bank Index relative to S&P 500 Index Relative to the S&P 500, S&P banks remain below the historical price/book value ratio. Price/book value suggest the stocks look undervalued. 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% +2σ, 85.7% +1σ, 74.8% μ, 63.9% -1σ, 53.0% 40.0% -2σ, 42.1% 30.0% 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Source: SNL Financial, LC;. We View S&P 500 Bank Stocks Valuation as Attractive at Current Levels 15
Future Profitability and Valuations Top 20 Bank Price to Book and ROACE Relationship Price to Book and ROACE Relationship Generally, a company s valuation will be based on its return on common equity and its level of risk. Companies that can not deliver an ROACE above its cost of capital will need to radically change. 250.0 Price/ Book (%) 200.0 150.0 100.0 y = 12.329x + 7.4653 R² = 0.6473 CFG ZION BAC CMA BK STI RF C KEY PNC COF MTB NTRS STT BBT FITB JPM HBAN WFC USB 50.0 0.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 Source: SNL Financial, LC;. ROACE (%) A Consistently Higher ROACE Leads to a Higher Stock Valuation 16
Merger and Acquisition Activity and Pricing Seller's Assets ($ Billions) 1,400 1,200 1,000 800 600 400 200-210% increase from 1990 to 1994 36 1990 169 291 1991 274 357 451 143 170 183 1992 1993 1994 524 486 1995 385 289 1,211 435 442 451 475 1996 1997 1998 287 1999 334 569 2000 Seller's Assets in Billions 237 117 318 145 431 369 1,313 253 262621 268 267 296 283 251 2001 2002 209 2003 2004 2005 2006 2007 2008 143 109 176 145 46 2009 Number of Deals Announced 216 223 287 165 194 137 111 147 2010 2011 2012 2013 2014 37 19-2015 YTD 600 500 400 300 200 100 Number of Deals M&A Activity The number of deals generally have increased from the low in 2009. The majority of the deals are done with targets of less than $1 billion in assets. Increased deal activity is expected in 2015 as deal prices rise to higher levels. Source: SNL Financial LC Data as of February 26, 2015 35.0X 30.0X In 2008, 4 of the top 5 deals were done at less than 35% of book value. 275 255 235 215 M&A Pricing Deal prices troughed in 2011 and have risen since. We do not expect deal pricing to come back to levels witnessed in the 1993-2008 period. Higher deal pricing is largely driven by the acquirer s stock valuation. 25.0X 20.0X 15.0X 10.0X 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 YTD 195 175 155 135 115 95 75 (%) Median P/LTM Earnings (left) Median P/BV (right) Source: SNL Financial, LC;. Merger and Acquisition Activity is Expected to Pick-up as Deal Pricing Increases 17
Interest Rate Tightening Periods Federal Funds Intended Rate vs. 10 Year Yield The Fed Funds rate has been at historical lows, while the 10-year treasury continues to be impacted by macro-geopolitical events. Historically, the 10-year treasury yield rises or falls before the Fed Funds rate. 10 yr Gov't Bond 2 Fed Funds Target 1 Lowest Yield at FF Rate @ Time of Date of Duration of Date of Yield FFunds Increase Duration of 1st FF Rate Increase FF Rate FF Rate Lowest Yield (%) (%) bps Δ Increase (%) Increase Increases Oct-93 5.33 5.97 64 4 months 3.00 Feb-94 12 months Dec-98 4.65 5.90 125 6 months 4.75 Jun-99 11 months Jun-03 3.33 4.73 140 12 months 1.00 Jun-04 24 months Jul-12 1.38 NA NA NA 0-0.25 NA NA (%) 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0-5.33 4.65 3.33 1.38 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Fed Funds Target 10 year Source: Federal Reserve. 1 Target rate denotes the rate at which Fed concludes period of monetary easing. The Fed stopped lowering rates on September 1992 at 3.00% and maintained this level for 17 months. 2 The lowest yield in the 10 year government bond represents the minimum recorded yield from the time the Fed concluded a period of monetary easing to when rates were eventually raised. When the intended fed funds rate was lowered to 3.00% in September 1992, the 10 year reached its minimum yield of 5.33% in October 1993 and had increased to 5.97% by the time rates were increased 4 months later. The Federal Funds Rate is Likely to Rise in 2015 but Will the 10-Year Treasury Rate Increase 18
30 day Federal Funds Futures implied rate vs S&P Regional Banking ETF 0.90% 44.00 0.80% 42.00 0.70% 30 day Federal Funds Futures implied rate 0.60% 0.50% 0.40% 0.30% 40.00 38.00 36.00 SPDR S&P Regional Banking ETF 0.20% 0.10% 34.00 0.00% Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 32.00 Fed Funds Dec 2015 SPDR S&P Regional Banking ETF Source: Bloomberg; FactSet Bank Stock Performance is Correlated with Fed Funds Expectations in Near-term 19
Federal Reserve Actions and Bank Stock Performance Bank Stock Performance Bank stock performance tends to be the strongest going into the first Fed Funds rate increase. Following a number of Fed Fund rate increases bank stock performance weakens. BIX 320.0 300.0 280.0 260.0 10 Yr Oct-93 Bottoms at 5.33% First Fed Funds Rate Increase Feb-94 to 3.25% Date Increase Decrease Level (%) 2/1/1995 50... 6.00 11/15/1994 75... 5.50 8/16/1994 50... 4.75 5/17/1994 50... 4.25 4/18/1994 25... 3.75 3/22/1994 25... 3.50 2/4/1994 25... 3.25 Last Fed Funds Rate Increase Feb-95 6.00% 37.0 35.0 33.0 31.0 29.0 BKX 240.0 27.0 220.0 10 Yr Nov-94 Peaks at 8.05% 200.0 May-93 Jul-93 Sep-93 Nov-93 Jan-94 Mar-94 May-94 Jul-94 Sep-94 Nov-94 Jan-95 Mar-95 May-95 Jul-95 25.0 23.0 Source: SNL Financial, LC; FactSet; Federal Reserve; BIX BKX At This Point in the Cycle, the Best Time to Own Bank Stocks is Six Months Prior to First Fed Funds Increase 20
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