Why Bank Shares Fell When The Fed Delayed Tapering Plans

Last Wednesday, September 18, the Federal Reserve sprung a surprise by announcing its decision to put off plans of tapering its bond purchase program by at least one more month. The move lifted investor spirits around the globe, visible from the following rally in shares across industries immediately after the Fed revealed its intention to continue buying $85 billion in bonds each month.

But investors in bank shares weren’t very amused by this development. On the contrary, the news actually triggered a sell-off in bank shares starting mid-Wednesday which continued all the way till end of trading on Friday, September 20, in the case of some of the banks. In general, the regional banks like PNC Financial (NYSE:PNC) and SunTrust (NYSE:STI) saw a bigger decline in share prices compared to their larger, more diversified counterparts like JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C). So what exactly explains this trend? After all, the Fed’s bond repurchase program is aimed at helping the economy recover faster, and faster recovery can only mean good news for banks as there will be more takers for their services ranging from lending to deposits to wealth management.

The answer to this apparent discrepancy lies in the expected impact of the tapering plan on the country’s interest-rate environment. As the Fed winds down its asset purchase plan, the interest rates will also begin to rise – a pre-cursor to which has already been witnessed since June when the Fed first announced its plans to initiated tapering. Among all the industries, the financial sector is obviously the one most sensitive to interest rates. More so given the shrinking net interest margins over the past several quarters in the wake of the prolonged low-interest rates maintained by the Fed. The banks – especially the ones whose business models rely more heavily on the traditional loans-and-deposits offering – are the one who would gain the most from the Fed’s tapering and the subsequent interest rate rise.

Now, with the market almost certain that the Fed will begin tapering bond purchases from September, investors had already priced in the potential upside to banks’ value over the recent months. This premium is what the bank shares lost over the last few days when the Fed decided to stay its course for the time being.

This also makes it evident why share prices for the regional banks were hit more than their larger counterparts, as the smaller banks rely almost completely on accepting deposits and handing out loans to generate income. Falling interest margins are, hence, likely to affect them more than others.

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