Today’s Yield Curve Solves Many Problems

Year-to-date in 2010, 325 banks have failed.   Like small boats on a rought sea, as loan losses pile up, these banks eventually succomb to the impossible obstacles they face.      There’s not doubt that many smaller banks face tough conditions right now. 

But this isn’t true for all banks.  Sure, many have failed and there are more to come, but there is smoother water ahead.   The steep yield curve promises that.

Right now, short term Treasuries (< 6 months) are paying near nothing.   Between .13 and .18%.   At the long end of the curve, 10-year and 30-year Treasuries are yielding about 2.55% and 3.98%, respectively.  

Today, because most deposits are short term (no specified duration), banks pay very little interest.  Bad for you but good for the banks.

Because while paying you that whopping 0.1% on your checking account, they have the option of buying higher-yielding, longer-term Treasuries or making new loans.  Lets see how the numbers work.

According to the FDIC, US banks currently hold a total of $8.242 trillion in deposits.   Of this total, only $6.675 trillion are interest paying deposits.  Lets assume all the banks, en masse, are paying a rate of 1% for these deposits.   At this rate, these deposits cost the banks about $67 billion per year.  Hmmm…sounds like a lot!

But before you break out the violin, lets see what they’re getting back.  The same FDIC site tells us these banks have $6.383 trillion in outstanding loans and leases.   And another $2.225 trillion in ‘securities’ investments. 

Most bank loans – even today – are pretty pricey.  Taken together, they must collectively yield well over 6%.   I would think even higher.  But using a 6% rate of return, the banks are earning about $383 billion per year.  Throw in another 2% on the securities (mostly longer term treasury investments), and we are up to over $427 billion a year. 

So they’re paying out about $67 billion and taking in about $427 billion.  Per year.   This leaves the industry with $360 billion PER YEAR of income from risk-free investments (treasuries) and loans to customers. 

And this doesn’t include all the fees, charges and investment returns from all other banking activities. 

So if you’re worried about the banks, I have a word of advice:  Don’t.  They’re taking in boat-loads of money today, more than enough to solve their legacy problems and challenges. 

The banking system is safe and sound.  Bank earnings, in this environment, have no where to go but up.   And up they will go.