'Operation Twist' Roils Bank Shares

The new Federal Reserve program to lower long-term interest rates means banks and brokerages are at risk for depressed earnings, with no real solution, and their shares reacted accordingly Thursday.

Operation Twist, announced by the Fed on Wednesday, is a $400 billion program to raise short-term interest rates and push down long-term rates. The Fed's idea is to make credit cheaper for consumers, thereby stimulating borrowing and the economy.

The problem is that banks and brokerage firms generally borrow short-term and lend long-term, meaning that if Twist works they are squeezed.

``Nearly every line is being marked down from our prior forecasts, which were not particularly optimistic to begin with,'' Barclays banking analyst Roger Freeman said in a note on Thursday.

In morning trading, Goldman Sachs (NYSE:GS) shares fell 3.6 percent to $94.22, their lowest level in two-and-a-half years. On Wednesday the stock closed below $100 for the first time since March 2009.

Morgan Stanley (NYSE:MS) shares dropped 6.8 percent. They fell sharply on Wednesday after Twist was announced and are now down five sessions in a row, losing more than 21 percent over that period. Since its 2011 peak in mid-February, the stock has lost nearly 60 percent of its value.

Goldman has fared a little bit better, but not much. The stock is down 13 percent in the last five sessions and down 44 percent from its mid-January peak.

Banks have been hammered in recent weeks by deepening fears about slowing markets. Barclays analysts said on Thursday they expect Goldman to report a third-quarter loss, the second in its history.

IN THE LINE OF FIRE

Brokers may fare little better, analysts said. Many brokers are having to waive fees on mutual funds, given their limited returns, while others are also getting hurt by a squeeze on margin lending.

``Generally speaking, earnings growth for (brokers) is at risk to a prolonged, low-rate environment,'' Bernstein Research analyst Brad Hintz said on Thursday.

Hintz singled out three names at risk -- Charles Schwab , TD Ameritrade and LPL -- and cut 2012 earnings estimates for all three by at least 10 percent.

Schwab shares fell 1.7 percent in early trading, while TD Ameritrade was off 1.3 percent. LPL shrugged off earlier losses and rose 0.3 percent.

Banks and brokers are not the only ones that are going to suffer the effects of Twist. Insurance companies and pension funds are also in the line of fire.

Life insurers rely on strong rates of return to meet their long-term obligations, both to insurance customers and to retirees who rely on annuities for income. Some actuaries say insurers may have to rethink their business models if rates stay low for years.

The nation's largest pension funds, already being battered by equity market weakness, will also be hurt by persistently low bond yields. The 100 largest pension plans already face an asset shortfall relative to obligations, which could get much worse in the next two years.

One bright spot -- or at least a less-dark spot -- may be retail banks such as Bank of America and Wells Fargo , among others. Though they have lamented the low-interest-rate environment like everyone else, analysts say their profile puts them at somewhat less risk.

``Where banks live is the 2-to-5-year period. The margin isn't driven primarily by the long end of the curve,'' said Jefferson Harralson, bank analyst with Keefe, Bruyette & Woods.

But even so, Harralson said, ``the overall rate environment is a really tough one right now, and if you layer Operation Twist on top of that, it becomes tough to make decent spreads.''

Bank of America (NYSE:BAC) shares fell 1.9 percent, as did Wells Fargo (NYSE:WFC) shares.