U.S. Fed offers support amid COVID-19

With rates cut to zero, investors should be seriously watching and considering bank stocks as this plays out

Eric Compton 16 March, 2020 | 12:53PM

The Federal Reserve released a flurry of announcements over the weekend, the most consequential of which was that it will cut the federal-funds rate an additional 100 basis points to a range of 0% to 0.25%. The Fed also announced it will increase its holdings of Treasury and mortgage-backed securities. Prior to this the Fed had been running off its MBS portfolio. Finally, the Fed announced a series of measures to "support the flow of credit to households and businesses," including: lowering its discount window rate; reducing reserve requirements for banks to zero; encouraging bank to tap into capital and liquidity buffers when needed to support lending to households and small businesses; and the extension of intraday credit to banks as needed. While there are quite a few moving parts in the Fed's actions, the most notable and consequential is the drop in rates to zero, which will hit net interest income for a slew of financial firms, and weigh on money market managers who will likely have to resort to fee waivers.

At this point, no one knows how long rates will stay at zero or what the overall impact of coronavirus will be on the U.S. and global economy. We do know that bank earnings will come under pressure in the short term as rates move to near zero. Having already updated most of our bank valuation models after the last rate cut just two weeks ago, we're going to hold off on updating them until we get clearer guidance from bank management teams during the release of first-quarter earnings. We expect the final hit to fair value estimates will likely be in the low-single-digit percentage range on average. We remind investors a few bad quarters of earnings are not that important when it comes to the intrinsic value of a firm over its lifetime. When bank stock prices imply that bad times will never end, we think the odds shift in the favor of long-term investors. We believe investors should be seriously watching and considering bank stocks as this plays out.

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Eric Compton

Eric Compton  Eric Compton is an equity analyst for Morningstar,

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