With the novel coronavirus creating widespread disruption across stock markets, the Federal Reserve is now intervening in a big way by dropping its benchmark interest rates practically to zero, starting its quantitative easing program again, and injecting $1.5 trillion into the overnight repurchase agreement operations (repo) market. The goal of the various moves (with more likely on the way) is to ensure that consumers can still take on credit, to protect liquidity in the banking system, and to support the smooth functioning of the bond markets.
Stock prices at the four largest banks in the country -- Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC) -- have been hit hard in past weeks. It's difficult to know if the Federal Reserve really has enough in its tool belt to overcome the economic effects of the COVID-19 pandemic. But if you are looking to buy at a potential bargain, one thing you can look at with a little more certainty from an investing standpoint is how these banks will fare under these monetary conditions.
Wells Fargo's margin is best-positioned
When interest rates decline, the banks that benefit in the short term are those that are liability sensitive. That means they have lots of fixed-rate loans that don't lose yield as interest rates reprice down, and also lots of interest-bearing deposits that reprice down with rates and get cheaper, which is great for banks. While none of the big four U.S. banks are liability sensitive, Wells Fargo is in the best position to weather the storm based on this metric.
According to recent earnings, 15% of Wells Fargo's total assets are in residential mortgages, the majority of which will not reprice for many years. Not only do these loans not reprice down with falling rates, but they will also likely generate a surge of refinancing activity, as borrowers look to lock in their home mortgages at lower rates. Refinancing could be one of the few bright spots for banks during a time like this. Additionally, about half of Wells Fargo's total funding sources are in interest-bearing deposits. None of the other big banks crack 10% when it comes to the ratio of residential mortgages to total assets, and the other three large banks also have a smaller percentage of interest-bearing deposits in their total funding mix.
The effect of quantitative easing
In addition to dropping rates, the Federal Reserve resumed a program first implemented during the 2008 financial crisis called quantitative easing (QE). The Fed began its QE program Monday, saying it would eventually buy $500 billion in Treasury bills and $200 billion in mortgage-backed securities from financial institutions. Although the long-term effect of QE is somewhat disputed, the measure is supposed to boost the profits of participating banks. Banks essentially sell Treasuries and mortgage-backed securities to the Fed, and then take the cash they get from those transactions and invest in riskier assets to increase profits. During the process, the Fed is essentially removing bonds from circulation, which theoretically should drive up demand and therefore bond prices.
Bank of America, according to its financial statements, has the most of these assets, with roughly $428 billion in U.S. Treasuries and mortgage-backed securities (MBS), although it's much more heavily weighted in MBS. But Wells Fargo has the second most, according to its financial statements, with roughly $320 billion in Treasuries and MBS, again more heavily weighted in MBS. JPMorgan has the most Treasuries with roughly $140 billion and therefore may be able to benefit more because the Fed is initially buying more of those assets than MBS.
Looking at context
Although this is how QE and lower interest rates have historically affected banks, it is still early, and the economic effects of the coronavirus are still largely unknown. Some believe monetary actions from the Fed will have muted effects on bank stocks. But most experts expect big banks to recover once the world recovers from the coronavirus outbreak. A recession is likely first, but bank stocks are pretty cheap right now and could go down even more. Additionally, measures like QE and low interest rates could stay in place for some time after the outbreak is solved to stimulate the economy again. A bank like Wells Fargo is overall better positioned to reap more of the benefits normally gained from QE and lower interest rates.