Big Banks Show Strength as Fed Doesn't Taper: Financial Winners

NEW YORK (TheStreet) -- Citigroup (C) was the winner among stocks of large U.S banks on Wednesday, with shares rising over 2% to close at $52.25.

The broad indices quickly reversed early losses and ended with 1% gains, after the Federal Open Market Committee released its statement at 2:00 p.m. ET, saying the Federal Reserve would not taper its monthly bond purchases until at least the next FOMC meeting on Oct. 29-30. The Committee "decided to await more evidence that progress will be sustained before adjusting the pace of its purchases," according to the statement.

The committee also said "these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate" of working to reduce unemployment and foster economic growth while keeping inflation in check.

Most economists had expected the Fed at least to make a slight reduction in its "QE3" balance sheet expansion. The central bank has been making monthly net purchases of $40 billion in long-term mortgage-backed securities and $45 billion in long-term U.S. Treasury bonds since last September. But the attempt to hold-down long-term rates for the most part has stopped working, as investors have been anticipating a reduction in bond purchases for quite some time, sending the yield on 10-year Treasury bonds up 100 basis points since the end of April. Mortgage refinance applications and total mortgage volume have been reduced considerably as a result. The FOMC also released revised economic projections, lowering their estimate of 2013 GDP growth to a range of 2.0% to 2.3% from the previous range of 2.3% to 2.6%. For 2014, the committee estimates GDP growth of 2.9%, down from its previous estimate of 3.1%. Federal Reserve Chairman Ben Bernanke during a press conference following the release of the FOMC statement said "We could move later this year," to reduce Federal Reserve bond purchases, but added that "subsequent steps will be data dependent."

"This FOMC edition feels less dovish than it does outright scared," wrote TD Securities global head of rates and commodity research Eric Green, in a note following the statement release. "The market now has to adjust to a new probability, that tapering is delayed into the new year," he added.

Investors made quite an adjustment to that "new probability," pouring money into 10-year Treasury bonds following the FOMC statement release, sending the yield on the 10-year way down by 15 basis points to 2.70%.

For bank stock investors, the endless "taper talk" misses a very important point: What most banks need for a significant boost to their net interest margins and net interest income is a parallel rise in interest rates. The FOMC has kept the federal funds rate -- its main policy tool -- in a range of zero to 0.25% since the end of 2008. The language in the statement on Wednesday provided a bit more direction on future policy for the federal funds rate from previous statements.

The FOMC made a slightly change in its language from the previous statement, saying its "highly accommodative" policy for short-term rates would "remain appropriate" at least until the national unemployment rate drops below 6.5%, assuming inflation projections remain in check, but added that it was likely to keep the federal funds rate in its current range "for a considerable time after the asset purchase program ends and the economic recovery strengthens." Considering that the tapering hasn't even started, this is bad news for bankers hoping for a parallel rise in rates. Illustrating just how important an eventual rise in short-term rates will be for bank profits, Deutsche Bank analyst Ryan Nash on Tuesday estimated that a gradual parallel rise in interest rates of 200 basis points -- which he acknowledged "rarely (if ever) happens -- would lead to a $1.178 billion increase in Citigroup's annual net interest income. Nash went further, estimating that $1.090 of the increase in Citi's net interest income would come from a rise in short-term rates. The KBW Bank Index (I:BKX) was up just 0.2% to close at 64.72, with 14 of the 24 index components ending the trading session with declines. The subdued overall reaction among bank-stock investors may have reflected concern over the industry's profitability as short-term rates remain near zero. Big banks ending with stock gains of over 1% included Bank of America (BAC), which closed at $14.71, and Wells Fargo (WFC), which closed at $43.31. RELATED STORIES: JPM Faces 'Months' of Regulatory Pain: Dimon Citigroup 'Faces Pressure' for Q3 Revenue: JPMorgan 'Grandpa' Goldman Trots Out History to Justify Commodities Business Has Dodd-Frank Lived Up to the Hype? Single-Family Housing Starts Rise 7% in August Next Banking Crisis an 'Easy Call': Mayo -- Written by Philip van Doorn in Jupiter, Fla. >Contact by Email. Follow @PhilipvanDoorn

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.