Banks feeling the squeeze
Moving money around never seemed like strenuous activity. So why are bankers starting to sweat?
Banks have produced remarkably good news over the past six years, while most industries stumbled through the ups and downs of the American economy. Profits climbed, stock prices rose, and almost everyone smiled. Depositors stuck with hideously low interest rates were the exceptions.
Financial reports coming in from banks now confirm the changing times that lenders had warned about much more recently. Business has gotten tougher, and the outlook for 2006 is more of the same. Consider two reports issued yesterday.
Profit at Bank of America Corp., the nation's second-largest bank, declined by 2 percent in the fourth quarter last year, and the bank forecast weak earnings growth in the ''low- to mid-single digits" for 2006. Bank of America says it was hit particularly hard by the flood of personal bankruptcies that took place last fall and flagging profits in its trading operation. But neither of those things was the problem that put a cloud over 2006 forecasts.
Meanwhile, TD Banknorth Inc. of Portland, Maine, reported its net interest income was roughly unchanged during the fourth quarter. Its actual profit was much higher, but the comparison doesn't mean much because the numbers were so skewed by Banknorth's sale last year to Toronto-Dominion.
The persistent problem at Bank of America, TD Banknorth, and most other US banking companies amounts to the same thing. It wasn't a killer, but it's not going away. If anything, it's getting worse.
The ''it" is interest rates, specifically the narrowing gap between the short-term and longer-term rates. Banks in the business of lending out deposits, which is how most make their money, capture profits in that margin between short- and long-term rates. Squeeze the margin and you squeeze a bank's ability to make money.
''It's all about the margin," Banknorth chief Bill Ryan said yesterday in a conference call. ''The flattening yield curve is here, and it looks like it's here for a period of time."
The yield curve is an arc drawn on a graph, representing interest rates as they climb higher over longer periods of time. If short- and long-term rates shift to become equal, the arc is hammered into a flat line.
That's bad enough, but banks are looking at other problems too. A flat yield curve often anticipates a weak economy, and that means waning demand for loans. The mortgage market in particular, a big driver of profits recently, won't be nearly so helpful this year.
One winner in this picture: Depositors who suffered through ultra-low interest rates, but only to a point. Banks won't pay up for deposits if loan demand sags because they won't have a good use for the money.
And banks will play tougher on deposits than loans to maintain interest-rate margins because they have alternatives to depositors if they need funds. The Federal Reserve, Federal Home Loan Bank, and commercial-paper markets are all available to banks and thrifts if their deposit costs get too expensive.
At the moment, smart banks are taking precautions that depress immediate earnings but also limit how much they could be hurt by interest rates later this year. Banks can pull in their horns by selling some portfolios or hedging against them, while resisting the urge to chase new business too hard.
If that doesn't sound like fun, it isn't. The party at the bank is over.
Steven Syre is a Globe columnist. He can be reached at syre@globe.com. 
