Savings And Loans Adapting To Flatter Yield Curve

The relatively sweet spot of this economic cycle may be coming to an end for the savings-and-loan industry, as the Federal Reserve gets ready to raise short-term interest rates. But you wouldn’t know it by looking at an industry stock chart.

The yield curve — a term that refers to the difference between short-term interest rates and longer-term rates, such as the 10-year Treasury — acts as a lifeline for the savings-and-loan industry. The greater the margin between the short- and long-term yield rates, the steeper the curve and the greater the profit potential for savings and loans.

With the Federal Reserve set to begin raising interest rates, possibly as soon as December, the yield curve is set to start flattening.

Federal Reserve Chair Janet Yellen speaks at the Federal Reserve Bank of St. Louis in September. The Fed has so far put off its first rate increase...

Federal Reserve Chair Janet Yellen speaks at the Federal Reserve Bank of St. Louis in September. The Fed has so far put off its first rate increase… View Enlarged Image

Even so, IBD’s Finance-Savings & Loan group on Friday ranked No. 5 out of 197 industries based on stock performance in recent months. How has this group managed to rise to become a top-performing industry even as the yield curve looks set to flatten?

The answer appears to be a mix of consolidation, execution and a tailwind of declining loan-loss reserves as the mortgage crisis recedes further into the past. There’s also hope for a respite from unusually stiff resistance coming out of Washington — costly regulatory compliance courtesy of Dodd-Frank — as the industry and its friends in Congress seek to protect so-called community banks from industrywide rules.

Anatomy Of Savings And Loans

Competing as a savings and loan, or thrift, against the mega-banks isn’t easy, even in the best of times. S&Ls have to provide a higher interest rate on deposits to attract customers because they generally don’t offer the full range of services provided by banks. Further, the Government Accountability Office, or GAO, concluded in a 2012 assessment of the impact of Dodd-Frank regulations that “larger banks generally are more profitable and efficient than smaller banks, which may reflect increasing returns to scale.”

Finally, there are also limits on the type of loans an S&L can make. The bulk of loans must be for home mortgages for an S&L to obtain low-cost funding from the Federal Home Loan Banks, with just 20% devoted to commercial loans.

Thrifts are portfolio lenders — they hold on to their mortgage loans rather than having them securitized or broken up into pieces and packaged with other loans to let investors spread their risk.

Because S&Ls retain the risk for the mortgages they underwrite, rather than farming out the risk via mortgage-based securities, they can be counted on to engage in more conservative underwriting, said Guggenheim Securities analyst David Darst.

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