Why I’m Still Not Buying Big-Bank Dividends

The fortunes of big banks were expected to take flight with the Federal Reserve’s first interest-rate increase this past December. We were told that bank fortunes would only gain altitude with each successive rate increase.
The logic seemed sound enough: The spreads between what big banks paid borrowers and what they received on loan assets would widen with each rate increase. More cash would flow in, so more earnings would flow out as big-bank dividends to shareholders. Share prices would rise, and everyone would be happy.
But like so much of what is packaged and sold by Wall Street, the goods failed to meet buyer expectations. Since the Fed raised the federal funds rate (the rate everyone refers to when they speak of the Fed “raising” interest rates), big-bank stocks have trended mostly in one direction – down.

Big-Bank Price Performance

The big-bank renaissance failed to materialize as planned, and I doubt that it will materialize in the near future.
Back in December, most economists were betting the farm that the first fed funds rate increase would be one of many more to come. The consensus was that the Fed would ratchet up the rate 0.25% in four-step fashion over 2016. By year’s end, the fed funds rate would range between 1.25% and 1.50% – a full percentage point higher than today. With a higher fed funds rate, not only would banks earn more from the deposit-loan spread, but they’d earn more on the amount the Fed paid on bank reserves.
If the Fed is anything, it’s as fickle as a teenage girl. Here we are a quarter of the way through 2016, and the Fed has backed away from its four-step boogie. Fed officials now hint that two increases are more likely, and even that’s an iffy proposition.
I say that because U.S. economic growth has hit the skids once again. Last week, in response to tepid personal spending data, the Federal Reserve Bank of Atlanta marked down its first-quarter gross domestic product growth estimate to 0.6%. Just a week before, the same Fed bank expected 1.4% first-quarter GDP growth.
But even if the big banks were able to earn more on the spread between interest paid on deposits and interest earned on loans, they would still need someone solvent to lend to. No sense in granting loans to someone unable to pay. That is an issue; big banks have lent liberally to borrowers whose ability to repay is questionable.
Bank of America (NYSE: BAC), Citigroup (NYSE: C), Wells Fargo (NYSE: WFC) and JPMorgan Chase (NYSE: JPM) have nearly $73 billion in outstanding loans to the energy sector. The Wall Street Journal reports that the number of energy loans labeled as “classified,” or in danger of default, could exceed 50% this year at several big banks. The Journal goes on to tell us that 51 North American oil and gas producers filed for bankruptcy over the past 15 months. These bankruptcies encompass $17.4 billion in cumulative debt.
More danger for big banks lurks in the guise of negative interest rates. In this scenario, the Fed would start charging banks to hold reserves with the Fed. (The Fed currently pays interest on these reserves.)  The theory is that negative interest rates force banks to lend. Banks don’t want excess reserves with the Fed, which would be an expense to the banks.
There are consequences, of course: If you increase lending to questionable credits, you risk higher defaults. If you’re forced to pass along your negative rates to depositors, as Japanese trust banks have begun to do, you risk depositors pulling out cash. Even a small fraction of deposits withdrawn from the system can have ramifications, such as the inability to clear checks or pay liabilities.
To be sure, negative interest rates in the United States are an outlier possibility, but not an impossible one. Over $7 trillion of government debt – in Europe and Japan – has a negative yield. For now, many large institutions are willing to pay to warehouse cash.
I’ve been down on big U.S. banks for years (read here and here). I see no reason to change my stance today. Their recent share-price performance only anchors my stance.
(Conversely, I have every reason to believe these particular stocks will continue rewarding shareholders over and over again.)