June 24, 2024 | Premium Service | In this special June Fishing Trip edition of The Institutional Risk Analyst, we set up the top seven US depositories for Q2 2024 earnings. On Wall Street, we are taught from an early age that past performance does not guarantee future results, but in banking an astute review of current performance does inform your view of the future in terms of earnings and credit losses. How do the actuals align with Street estimates?
West Grand Lake from Leen's Lodge | Midsummer 2024
As of the Friday close, the WGA Bank Top 10 Index was up over 12% YTD while the Invesco KBW Bank ETF (KBWB) was up a little more than 6.6% over the same period. How could a bunch of smaller specialized banks possibly outperform the larger quasi-monopolies so beloved by equity managers?
Below we show the WGA Bank Top Ten Index constituents and the top ten US banks by assets and also the score for these banks in the WGA Bank Top 100 Index for Q2 2024. Subscribers to the Premium Service have access to the WGA Bank Top 100 Index each quarter including the index weightings. We rebalance the indices about 30 days after the quarter closes.
Notice that JPMorgan (JPM) is the only name that is included in both groups of banks, a rather telling comment on the relative strength of some of the larger depositories by assets in the US. When Fed Chairman Jerome Powell intones publicly that US banks are in good shape, do you think he knows the hard truth? In fact, US banks are in the worst shape since 2008.
Last week we learned that four of the biggest banks on Wall Street must improve their "living will" blueprints for a hypothetical wind-down. The Fed and other US regulators found weaknesses in their resolution plans. But is a wind-down even possible without a public subsidy given the financial problems in the industry? No.
It strikes us as rather facile for regulators and members of Congress to fret about "living wills" when much of the banking industry is visibly insolvent. Perhaps this is the same mental infirmity that enables us to think that $35 trillion in public debt is acceptable? In the event of a bank failure, the folks in resolution and recovery at the FDIC won't even look at the living will.
As discussed below, the good news is that the mark-to-market losses of US banks are not as bad as Q4 last year. If we adjust both securities and loans held-to-maturity, however, the results are still quite shocking. Higher for longer has still created a capital deficit of $1.3 trillion as of Q1 2024. This result is better than the $1.7 trillion capital deficit in October of 2023, yet the magnitude of the losses are very troubling.
Since residential mortgages touched 8% for a week last October, average MBS coupons have risen but so has the 10-year Treasury yield. As we think about the actual solvency of US banks, let’s ponder some reference points. Fannie Mae 3.5% MBS for delivery in July are trading around 89 bid. MBS spreads are at a five-year wide vs the 10-year Treasury note. The yield on the $842 billion in securities held by Bank of America (BAC) is less than 3%, as of Q1 2024. Fannie Mae 3s are trading at 85 on the bid side.
Mark-to-Market ($M) | All Banks | Q1 2024
Source: FDIC/WGA LLC
Keep in mind that the US banking industry has a solvency problem even before we start to talk about credit risk on commercial mortgages and busted corporate loans from leveraged buyouts (aka "private credit"). The situation is slowly improving as assets reprice, but the earnings of banks which survive the next 12 months could be impacted by mark-to-market losses for many years to come.
As we reported earlier, credit risk sharing is now a key tool for many banks to manage losses on loans and securities (“Will Credit Risk Transfer Save the Banks? Are MSRs Overvalued?”). “Regional banks around the U.S. are striking complex and costly bargains with hedge funds, hoping to insulate themselves from a replay of the turmoil that followed Silicon Valley Bank’s failure last year,” the Wall Street Journal reports. “Wall Street smells a payday.”
No, banks smell possible survival by selling credit risk. Critics of credit risk sharing transactions need to have an alternative in mind before they start pontificating about a topic few pundits actually understand. If a bank can raise new equity capital, then that is the first option.
But if the bank cannot raise new equity and, indeed, cannot quantify net asset values to the satisfaction of credit investors, then we have a problem. Either we encourage private risk transfers for banks or Congress needs to think about legislation to provide say a $2 trillion emergency backstop for the FDIC.
The Top Seven Banks by Assets
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