November 23, 2020

Banks Will Thrive If Yield Curve Steepens on Optimism

EXCERPT: Recent news about a COVID-19 vaccine that's ready for distribution has led to a sharp steepening of the yield curve, which is a good thing for banks as interest margins will increase, and profits will follow.

Pfizer recently announced its vaccine is 95 percent safe and effective, which is news that helped drive the yield curve to steepen sharply.

Positive outcomes surrounding the clinical trials on COVID-19 vaccines from big pharma companies like Pfizer and BioNTech is good news for banks and lenders. An early vaccine with a success rate of as much as 95 percent recently steepened the yield curve and will help financial institutions thrive as a result.

If the bond market continues on this path, interest rates will increase, and bank profit improvement should follow.

Efforts being made to improve the economy after months of grim outlooks can be boosted much faster with a vaccine that is quickly distributed throughout the nation. As more Americans get immunized against the novel coronavirus, herd immunity can be reached, which will eventually help to ease the social restrictions that have been placed since the pandemic first struck in the spring.

Positive News About a COVID-19 Vaccine May Lead to Increased Rates to Boost Margins

A more positive outlook can help send interest rates up and widen margins for banks, thereby increasing profitability from loans.

Upon the news from Pfizer and BioNTech of an early vaccine that's been shown to be both safe and effective, the gap between long and short-term borrowing costs stretched. The difference between 10-year and three-month Treasuries recently reached 0.85 points. That's the highest point seen since the pandemic hit and is much higher than August's low of approximately 0.42 points.

Bank of America realized a sharp increase in its share price as the yield curve steepened following news of an early vaccine.

Banks like JPMorgan Chase, Bank of America, Comerica, M&T Bank saw an increase in shares as the yield curve steepened.

Bank profitability relies a great deal on how much interest is paid on short-term borrowing deposits and loan yields. With a small difference between the two, profits suffer. But as the gap widens with the steepening of the yield curve, profits can soar.

Four of the largest lenders in the country could see an increase of $22 billion in annual revenue with just a 1 percent increase in interest rates from September's forecast across several maturities. Bank of America alone could see an extra $3.3 billion in revenue with a 1-point increase in long-term rates and another $6.4 billion with an increase of 1 percent in short-term rates.

The Federal Reserve says it will leave short-term rates at low levels for the next three years and is making an effort to keep long-term rates low as well by purchasing Treasuries. But banks need rate levels to rise along with a steepening yield curve in order for profitability to increase. But perhaps even the recent small increase in the two-year yield shows that perhaps the central bank could increase rates in the next two years, which would be a good thing for banks.

Banks Can Use This Time to Make Room on the Books For New Assets

While the recent steepening yield curve may not necessarily be a long-term environment, it's still a positive event that can help boost bank profitability. And with a steepening yield curve comes increased bank interest margins and profits to follow.

Now may be the ideal time for banks to clear the books of sub-performing assets and focus on new business. Garnet Capital has a network of qualified buyers and sellers to help banks sell off risky assets and fill their spots with more higher-performing ones.

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