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Regions Financial says that it is planning for an increase in regulatory capital requirements and would be able to manage new regulations for risk-weighted assets, but it also said that raising the capital threshold is unnecessary.
David Turner, chief financial officer of the $156 billion-asset bank, told analysts Friday during the company’s second-quarter earnings presentation that Regions was expecting effective minimum capital standards to rise, and is preparing for a 6% risk-weighted asset requirement for banks over $100 billion of assets.
“Maybe there’s some tailoring,” Turner said, but based on a 6% threshold, Regions would need to raise an “incremental” $5 billion of debt. The potential capital requirement would create an “all-in cost” for Regions of around $35 million or a “bottom-line hit” of 60 to 70 basis points, he said.
“It’s not something that is pretty easy to overcome,” Turner told analysts. “We don’t think it’s necessary, but we don’t get to make the rules. We just have to adapt and overcome.”
The potential changes Turner was referencing could be part of a Federal Reserve proposal expected next week related to the final implementation of the Basel III international regulatory framework, also known as the Basel III endgame. The Fed has scheduled an open meeting to discuss it Thursday.
A series of bank failures that began earlier this year with the collapse of Silicon Valley Bank in March has prompted regulatory discussion led by the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.
Policymakers and banking industry officials have debated back and forth about whether and by how much existing rules should be toughened to better insulate regional banks in particular from financial or economic shocks.
Key issues of the debate have circled around raising certain capital requirements to include banks with assets of $100 billion or more and whether additional regulation would increase the cost of capital at traditional banks and tilt market activity toward less-regulated nonbank lenders.
The Birmingham, Alabama, bank will be able to “overcome whatever it is that we have to [meet]” if regulators enact new capital requirements, Turner said during Friday’s earnings call.
“We think the Fed’s going to give us all the time to adapt to whatever those changes are going to be without any major disruption,” Turner said.
Regions was among the hardest-hit regional lenders amid sudden deposit runoffs and other volatility that slammed the sector earlier this year. At the end of the first quarter, Regions reported a 2.5% decline in deposits since the end of last year and a 9% drop from the first quarter of 2022.
The bank’s total deposits declined further in the second quarter — to $127 billion — but at a slower pace. Deposits at June 30 were 1% lower than on March 31 and 8% lower than in mid-2022.
An analyst’s question to Regions about its exposure to office-related commercial real estate assets highlighted ongoing concerns about underlying risks that could be present throughout the banking industry.
The bank holds a $1.7 billion office portfolio, which consists of “well-secured” single-tenant assets with 82% considered investment-grade, Regions CEO John Turner told analysts.
He said that the bank’s multi-tenant office assets are based mostly in Sun Belt states and are “well diversified geographically.”
Regions reported net income of $581 million at the end of the second quarter, which was a 5% decline from the first quarter and flat compared with the same period last year. Net interest income fell by 2.5% during the second quarter to $1.4 billion but increased by 25% compared with the year-earlier period.
Noninterest income climbed by 8% to $576 million during the second quarter but declined by 10% compared with the second quarter of 2022. Regions cited gains in its capital markets and credit card businesses that were offset by declines in other categories which include service charges on deposit accounts.
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Executives at Comerica are now forecasting an even steeper decline in deposits for all of 2023, but the pace of outflows keeps slowing, and they hope that some deposits that fled might return.
Average deposits are now expected to decrease 14% to 15% compared with last year, executives said Friday during the Dallas-based company’s second-quarter earnings call. That’s steeper than the 12% to 14% decline predicted in April, and the 9% to 10% decline predicted in March.
Comerica CEO Curtis Farmer reiterated that while the company has seen an exodus of deposits — about $3.7 billion was withdrawn after the March failure of Silicon Valley Bank sparked several weeks of liquidity concerns across the industry — Comerica did not lose customers. And the crisis-induced push to put deposits into different accounts appears to be largely over, he added.
“We saw some customers diversify deposits,” Farmer said. “And we hope over time — and seeing some signs, early signs of that — that customers will bring some of those deposits back.”
The $90.4 billion-asset Comerica is one of several regional banks that experienced rapid deposit outflows this spring, especially among technology and life sciences customers who sought to diversify where they park their cash. Some other regionals, including Huntington Bancshares, Synovus Financial, M&T Bank and Fifth Third Bancorp, reported an uptick in deposits for the second quarter as the turmoil has eased.
Deposits at the company, which peaked at $82 billion during the pandemic, have been shrinking for several quarters. The events this spring accelerated the outflow, but the company, which has a large base on non-interest-bearing deposits, had been anticipating some outflow due to rising interest rates and customers’ desire to shift into interest-bearing accounts.
The company is now projecting year-end deposits to hover in the $63 billion to $64 billion range.
“I think the takeaway is that the industry has stabilized since March and there’s not this panic going on,” Christopher McGratty, an analyst at Keefe, Bruyette & Woods, said Friday in an interview. Comerica’s “deposit issue isn’t going away, but it’s not getting worse at this juncture.”
Average deposits at Comerica totaled $64.3 billion during the second quarter, down 17.1% year over year and down 5.2% compared with the first quarter of this year. The revision to the full-year guidance is a reflection of the Federal Reserve’s ongoing quantitative-tightening program that began last year and the impact of the industrywide turmoil, executives said Friday.
Non-interest-bearing deposits made up around 47% of Comerica’s total deposit base as of June 30, the company reported. That figure will probably “dip slightly” to around 44% to 45% by the end of this year, Chief Financial Officer James Herzog said during the call. The 47% includes period-end “elevated” customer balances that are expected to exit or have already moved out, he said.
Exactly how that percentage unfolds depends on several factors, including how successful Comerica is in bringing back interest-bearing deposits, Herzog said.
“And we would, of course, welcome back those interest-bearing deposits,” he added.
Like some regional banks, Comerica is tweaking its balance sheet strategy. In June, it announced that it would wind down its mortgage warehouse business, and it is being more selective in terms of loan growth, which should lift capital ratios through year-end, Herzog said.
Combined, those decisions should keep loan growth “relatively flat” for the third quarter, he said.
As for the future of deposits in technology and life sciences, which started declining last year amid a slowdown in the tech sector, Comerica has no plans to step away from that business.
The cash burn that those companies are experiencing probably isn’t over yet, but it will eventually be a case of cash-building at some point, said Peter Sefzik, Comerica’s chief banking officer.
“We’ve been in that business a long, long time,” Sefzik said. “We plan to stay in it.”
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JPMorgan Chase & Co., the largest U.S. bank, has been wading into artificial intelligence to a greater extent than its rivals and is now producing a series of research notes that are AI-generated.
The move represents something of a step forward in an area that’s been seen as ripe for disruption — investment research — at a time when the AI revolution is taking hold on Wall Street. At JPMorgan, AI is being used to create short summaries of human-produced reports and to link those reports inside the firm’s Cross Asset Spotlight.
Questions remain over how far machine-generated research can go in replacing humans, and regulations on it are still in the early stages — putting pressure on Wall Street banks to be completely transparent about how their research is being put together. Research reports are generally subject to rules from Finra, or the Financial Industry Regulatory Authority, which require that a qualified registered principal approves a report prior to distribution to the public. Banks may also include legal or compliance approvals as part of their process. Through a spokeswoman, JPMorgan
JPM,
declined to comment for this article.
In a disclaimer attached to JPMorgan’s Cross Asset Spotlight note, primary authors Thomas Salopek and Federico Manicardi cited the large amount of content that investors need to sift through in constantly-moving markets as part of the reason that AI is being used. Salopek and Manicardi said they can produce an AI-generated summary of the most relevant and recent analyst reports on a particular topic or event — as they did on Tuesday with a focus on earnings, China, the soft-landing scenario, and AI’s impact on U.S. interest rates.
“What seems to be going on here is that they’re using an AI-based system to build a summary publication of existing human-generated reports that are already out there,” said Michael Wagner, co-founder and chief operating officer of Omnia Family Wealth, a multifamily office based in Miami, which oversees more than $2.5 billion and is already using AI to assist with its client conversations.
“It certainly is still relatively unusual, but I think analyst jobs are safe for now,” Wagner said in an email to MarketWatch. “It’s an interesting development that shows how AI-driven automation could impact labor markets. If relatively repetitive ‘knowledge work’ can be automated in this fashion, banks and law firms may not need as many lower-level employees as they do today.”
New York-based JPMorgan has been leading Wall Street’s shift toward AI in a number of different ways. From February through April, the bank advertised more than 3,600 jobs globally that are all related to AI, according to Bloomberg. In May, it filed a patent application for its own software, known as IndexGPT, which can be used for analyzing and selecting securities for its clients. And JPMorgan has also created a tool that scans speeches by Federal Reserve officials to detect policy shifts and potential trading signals.
WSJ: Pro Take: JPMorgan’s Fedspeak Evaluator Is Unsure About This Week’s Rate Decision
Rivals of JPMorgan haven’t gone quite as far. Representatives of BofA Securities
BAC,
Citi
C,
and Deutsche Bank
DB,
said their organizations haven’t produced any AI-generated research notes.
Goldman Sachs
GS,
has written about the economic and market impacts of AI, but hasn’t used the technology to write text for its research yet, according to economist Joseph Briggs and chief global strategist Praveen Korapaty. Morgan Stanley
MS,
declined to comment through a spokeswoman.
As of Friday afternoon, U.S. stocks
DJIA,
COMP,
were heading higher as investors prepared for a major rebalancing of the Nasdaq-100 index and the expiration of trillions of dollars of stock option contracts. Meanwhile, Treasury yields were mixed ahead of next week’s policy announcement by the Federal Reserve.
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By Dominic Chopping
Nordea Bank on Monday raised guidance and posted a forecast-beating second-quarter net profit as net-interest margins improved and corporate lending grew.
The Helsinki-based bank posted net profit attributable to shareholders of 1.34 billion euros ($1.5 billion), from EUR1.06 billion in the same period a year earlier, as net-interest income rose 40% to EUR1.83 billion.
A poll of analysts by FactSet had forecast net profit of EUR1.26 billion and net interest income of EUR1.8 billion.
“It is clear that the economic slowdown and interest rate increases have had a negative impact on our business volume growth, mainly in mortgages,” Chief Executive Frank Vang-Jensen said.
“Our corporate lending volumes continue to grow, particularly in Norway and Sweden.”
Full-year 2023 return on equity is now expected to be above 15%, from above 13% previously. Nordea maintained its full-year 2025 financial target of return on equity above 13%, supported by a cost-to-income ratio of 45%-47% and an annual net loan loss ratio of around 10 basis points.
“We are reassessing our long-term financial target for 2025. We will provide a target update in conjunction with the release of our fourth quarter report,” Vang-Jensen said.
Nordea’s common equity Tier 1 ratio was 16.0%, from 16.6% a year earlier.
Write to Dominic Chopping at dominic.chopping@wsj.com
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JPMorgan Chase & Co. Chief Executive Jamie Dimon on Friday said the U.S. economy was basically doing OK, even if customers were spending “a little more slowly.”
But with rivals like Bank of America Corp., Goldman Sachs Group Inc. and American Express Co. set to report quarterly results this week, recession agita still prevails.
For evidence, look no further than JPMorgan’s
JPM,
own quarterly results. The bank’s second-quarter profit blew past expectations, but it set aside $2.9 billion during the second quarter to cover potentially bad loans, amid concerns that more consumers could run into more difficulty paying their bills on time as higher prices manage to stick at stores.
That figure was well up from $1.1 billion in the same quarter last year, although still far below the billions it stowed away when the pandemic first hit. Similarly, Wells Fargo & Co.
WFC,
on Friday set aside $1.7 billion for loan losses in this year’s second quarter, nearly triple what it was a year ago.
The figures underscore the anxiety over the second half of this year, when many economists expect the economy to tilt into a recession. However, for the 500 companies in the S&P 500 index, Wall Street analysts still expect profit growth.
Any downturn could be exacerbated by the pressure investors have put on companies, potentially via more layoffs and money-saving technology, to keep prices high and cut costs to replicate the abnormally large profit-margin gains they put up in 2021 and 2022. Businesses have indeed kept prices high, at least for many basic necessities, in an effort to cover their own higher costs and to pad profits.
When Bank of America
BAC,
reports this week, the results will narrow the lens on lending and spending in the U.S. Results from Morgan Stanley
MS,
and Goldman Sachs
GS,
will fill in the gaps on trading and deal-making. American Express
AXP,
will give a more detailed breakdown of what consumers are still spending their money on, after Delta Air Lines Inc.
DAL,
— which has a partnership with AmEx — said that travel demand remained “robust.”
Banks shoveled more money into their reserve stockpiles in 2020 to bulk up against the pandemic’s shutdown of the economy. A year later, they started releasing those funds as the economy reopened and recovered. FactSet expects the broader banking sector to plump up its cash cushion during this year’s second quarter to account for more late loan payments or potential defaults.
In a report on Friday, FactSet said the 15 banking-industry companies in the S&P 500 Index tracked by the firm were on pace to set aside $9.9 billion to cover losses from souring loans in the second quarter. That’s more than double the amount set aside a year ago. And if that $9.9 billion figure, based on actual and projected financial figures, ends up as the actual figure at the end of the quarter, it would mark the highest since the beginning of the pandemic and the third highest in five years, according to FactSet data.
“The U.S. economy continues to be resilient,” Dimon said in a statement on Friday. “Consumer balance sheets remain healthy, and consumers are spending, albeit a little more slowly. Labor markets have softened somewhat, but job growth remains strong.”
However, he noted difficulties in JPMorgan’s investment banking segment. And he said consumer savings were slowly eroding as inflation endures.
As the nation’s biggest bank, JPMorgan has flexed its financial muscle this year, swallowing up First Republic after that bank got into trouble. But as it consolidates power and influence, building thicker armor against shocks to the economy, its financial results might not always reflect the struggles of its smaller rivals, where difficulties are likely felt more acutely. Analysts at Raymond James said that while JPMorgan remained a “best in breed” bank, its outlook pointed to “heightened challenges for smaller banks.”
See also: Jamie Dimon says U.S. consumers are in ‘good shape.’ This evidence may prove otherwise.
For the week ahead, 60 S&P 500 companies, including five from the Dow, will report quarterly results, according to FactSet. Two big oil companies, Halliburton Co.
HAL,
and Baker Hughes Co.,
BKR,
will report, as oil prices fall from levels seen last year. Results from two transportation giants — trucking company J.B. Hunt Transport Services
JBHT,
and railroad operator CSX Corp.
CSX,
— will also be a proxy for how much people are buying things and having them shipped. United Airlines Holdings Inc.
UAL,
and American Airlines Group
AAL,
will also report.
Netflix results: Hollywood shutdown, ‘slow-growth’ expectations. Hollywood’s writers — and now its actors — have gone on strike, and Netflix Inc.
NFLX,
reports second-quarter results on Wednesday. The streaming platform will likely face questions over how much content it has left in the tank, as the strike upends studio-production schedules and leaves viewers with vast expanses of reruns. Still, Macquarie analyst Tim Nollen said that the production standstill “may ironically drive even more viewers to streaming services.”
The writers and actors argue that the studio industry — increasingly consolidated, increasingly publicly traded, increasingly oriented around a handful of film franchises — has profited immensely while skimping on things benefits and streaming residuals. But after a decade-long rise, and a recent shift in investor focus from subscriber growth to profit growth, Netflix has emerged as one of the biggest production powerhouses in the business. And after years of flooding customers with new films and shows, it’s trying to squeeze out sales via more boring ways: things like a password-sharing crackdown and ads.
Daniel Morgan, senior portfolio at Synovus Trust Co., said Netflix still faced a plenty of streaming competition amid “muted” subscriber growth. But Wedbush analyst Michael Pachter said investors should look at Netflix as a profitable, albeit more mature company.
“We think Netflix is well-positioned in this murky environment as streamers are shifting strategy, and should be valued as an immensely profitable, slow-growth company,” Pachter said in a research note on Friday.
“Even while the ad-supported tier is not yet directly accretive (we think it will be accretive over time), the ad-tier should continue to reduce churn and draw new subscribers to the service,” he continued.
Tesla sales. Electric-vehicle maker Tesla Inc. also reports second-quarter results on Wednesday. And like streaming, some analysts say the fervor for EVs has faded.
However, they also said that Tesla
TSLA,
had so far been immune from the malaise. And even though Elon Musk remains preoccupied with Twitter — which now faces competition from Meta Platforms Inc.’s
META,
Threads — Tesla’s second-quarter deliveries were far above expectations. Sales are expected to be big. And one analyst said that price cuts, which Tesla has used to capture more of the auto market in China, were likely “fairly minimal” during the second quarter. But some analysts wondered what the blowout delivery figures would mean for margins. And the industry, broadly, has increasingly tested the patience of profit-minded investors.
“We’ve now seen a market where demand is constrained, capital has been tighter, and there is less tolerance for EV related losses,” Barclays analysts said in a note last week, adding that there was a “step back from EV euphoria.”
Claudia Assis contributed reporting.
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Major U.S. banks including Morgan Stanley and JPMorgan Chase & Co. announced dividend increases late Friday, in the wake of the results of the Federal Reserve’s latest bank stress tests earlier this week.
JPMorgan
JPM,
said it plans to raise the bank’s dividend to $1.05 a share, up from $1 a share, for the third quarter, subject to board approval.
The stress tests “show that banks are resilient — even while withstanding severe shocks — and continue to serve as a pillar of strength to the financial system and broader economy,” JPMorgan Chief Executive Jamie Dimon said in a statement.
“We continue to maintain a fortress balance sheet with strong capital levels and robust liquidity,” Dimon added.
Morgan Stanley
MS,
said it will increase its quarterly dividend to 85 cents a share from the current 77.5 cents a share, beginning with its third-quarter dividend. The bank also said that its board reauthorized a multiyear share buyback totaling as much as $20 billion, without an expiration date, beginning in the third quarter.
Don’t miss: Fed stress tests see large banks able to handle recession and slide in commercial-real-estate prices
See also: Wall Street upbeat on banks after ‘mostly positive’ Fed stress tests results
“The results of the Federal Reserve’s stress test demonstrate the durability of our transformed business model. We remain committed to returning capital to our shareholders and are raising our dividend by 7.5 cents,” Chief Executive James P. Gorman said in a statement.
Wells Fargo
WFC,
for its part, said it will increase its dividend to 35 cents a share, up from 30 cents a share, subject to board approval. It said it has the capacity to undertake a share buyback, “which will be routinely assessed as part of the company’s internal capital adequacy framework that considers current market conditions, potential changes to regulatory capital requirements, and other risk factors,” without elaborating further.
Goldman Sachs Group Inc.
GS,
said it would raise its dividend, to $2.75 a share from $2.50 a share, starting July 1.
Market Pulse: Goldman Sachs reportedly looking to exit Apple partnership
Citigroup Inc. C said its board had approved an increase in its quarterly dividend to 53 cents a share, from 51 cents, also for the third quarter.
Citi Chief Executive Jane Fraser said that, while the bank “would have clearly preferred not to see an increase in our stress capital buffer, these results still demonstrate Citi’s financial resilience through all economic environments, including the severely adverse scenario envisioned in the Federal Reserve’s stress test.”
Citi’s “robust capital and liquidity position, as well as the diversification of our funding and our business model, allow Citi to continue to be a source of strength for our clients and navigate challenging macro environments securely,” Fraser said.
The bank bought back $1 billon in shares in the second quarter and will continue to evaluate its capital actions, the chief executive said. “We are completely committed to simplifying Citi, improving returns and delivering value to our shareholders.”
Shares of Morgan Stanley and Wells Fargo rose 1.5% and 0.1%, respectively, in the after-hours session after ending the regular trading day up a respective 0.2% and 0.5%. JPMorgan shares edged up 0.2% in the extended session after closing 1.4% higher on Friday. Citigroup shares were up 0.2%, while Goldman’s were largely unchanged.
Bill Peters contributed.
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The U.S. Federal Reserve said Wednesday that all 23 banks in this year’s stress tests withstood a hypothetical “severe” global recession and losses of up to $541 billion as well as a 40% decline in commercial real estate prices.
The banks in the 2023 stress tests hold about 20% of the office and downtown commercial real estate loans held by banks and should be able to handle office space weakness that has loomed amid slack demand for space in the wake of the COVID-19 pandemic.
“The projected decline in commercial real estate prices, combined with
the substantial increase in office vacancies, contributes to projected loss rates on office properties that are roughly triple the levels reached during the 2008 financial crisis,” the Fed said in a prepared statement.
Fed vice chair of supervision Michael S. Barr said the exams confirm that the U.S. banking system remains resilient, even in the wake of the failure of Silicon Valley Bank, Signature Bank and First Republic Bank earlier this year.
Barr also alluded to comments he made last week when he said the Fed should consider a wider range of risks that could derail banks in a process he described as reverse stress tests.
“We should remain humble about how risks can arise and continue our
work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses,” Barr said in a prepared statement.
The bank stress tests are closely watched because they help determine what capital banks have left over for stock buybacks and dividends. However, expectations are not particularly high at the current time for any huge payouts to investors given talk by regulators about high capital requirements tied to Basel III international banking laws, as well as a challenging economic environment with interest rates on the rise in an attempt to cool economic activity and tame inflation.
Senior Fed officials said banks will be clear to provide updates on their stock buybacks and dividends after the market close on Friday.
For the first time, the Fed conducted an “exploratory market shock” on the trading books of the U.S.’s eight largest banks including greater inflationary pressures and rising interest rates.
The results showed that the largest banks’ trading books were resilient to the rising rate environment tested. That group included Bank of America Corp., the Bank of New York Mellon, Citigroup Inc., the Goldman Sachs Group Inc., JPMorgan Chase & Co. , Morgan Stanley , State Street Corp, and Wells Fargo & Co.
Senior federal officials said they’re studying a wider application of the exploratory market shock to other banks.
In last year’s tests, the Fed did not place an emphasis on a rapid rise in interest rates partly because expectations were high for a recession with lower interest rates in 2023. Instead, interest rates rose. That market dynamic was a factor in the collapse of Silicon Valley Bank, which sold securities with lower interest rates at a loss to cover an increase in withdrawals, only to spark a run on the bank.
All told, the Fed said the 23 banks in the stress test managed to maintain their capital requirements even with a projected $541 billion in losses. (See breakdown below).
Under the most severe stress, the aggregate common equity risk-based capital ratio would decline by 2.3% to a minimum of 10.1%.
Other facets of the hypothetical recession included a “substantial” increase in office vacancies, a 38% reduction in house prices and a 6.4% increase in U.S. unemployment to a high of 10%. The drop in house prices in this year’s stress tests is worse than the decline in the Global Financial Crisis in 2008.
“The results looked pretty good,” said Maclyn Clouse, a professor of finance at the University of Denver’s Daniels College of Business. “The banks were in pretty good shape from a capital standpoint and they’d be able to withstand some shock. It’s good news.”
Barr’s remark on Fed officials being “humble” reflects the fact that regulators largely missed the Global Financial Crisis as well as the sudden demise of Silicon Valley Bank in March.
“They need to be humble,” Clouse said. “We need to be a little more humble about the results and a little more alert about new challenges that normally haven’t been looked at with stress tests.”
This year, the banks that took part in the stress tests including Bank of America Corp.
BAC,
Bank of New York Mellon Corp.
BK,
Capitol One Financial Corp.
COF,
Charles Schwab Corp.
SCHW,
Citigroup
C,
Citizens Financial Group Inc.
CFG,
and Goldman Sachs Group Inc.
GS,
Other exams took place at J.P. Morgan Chase & Co.
JPM,
M&T Bank Corp.
MTB,
Morgan Stanley
MS,
Northern Trust Corp.
NTRS,
PNC Financial Services Group Inc.
PNC,
State Street Corp.
STT,
Truist Financial Corp.
TFC,
U.S. Bancorp
USB,
and Wells Fargo & Co.
WFC,
In 2022, the Fed said banks could withstand 10% unemployment and a 55% drop in stock prices as part of the year-ago stress test.
KBW analyst David Konrad said in a June 22 research note he expected no “huge surprises” in addition to capital uncertainty around dividends and buybacks already expected by Wall Street.
Providing guidance on how the Fed will study bank strength, Fed chair of supervision Michael Barr said last week that the Fed needs to consider “reverse stress tests” to look at “different ways an institution can die” instead of simply submitting banks to a specific list of hypothetical hardships.
“We have to work harder at looking at patterns we haven’t seen before,” Barr said at an appearance on June 20.
Also Read: Fed official eyes ‘reverse stress tests’ for banks as results awaited after 2023 bank failures
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Financial disruptions in 2008 contributed to the deep economic downturn that came to be known as the Great Recession. Could recent bank failures similarly lead to a broad U.S. recession?
The $532 billion of assets of the three banks that failed in March and April 2023 exceed the inflation-adjusted value of $526 billion of assets of the 25 banks that failed in 2008. Yet the current situation differs in many ways from the underlying economic circumstances at the outset of the Great Recession.
Still, that experience, as well as others, show how financial distress can lead to macroeconomic weakness which then contributes to further financial distress, resulting in a downward spiral during which credit becomes tight, investment is curtailed and growth stalls.
Bank distress can have adverse consequences for borrowers and the broader economy. One source of recent U.S. bank vulnerabilities is the rapid increase in interest rates. Banks take in deposits that can be withdrawn in the short term and use them to make loans and invest in securities at interest rates that are fixed for some time.
As interest rates rise, the value of banks’ existing portfolio decreases as new investments at higher rates are more attractive. By one estimate, the U.S. banking system’s market value of assets is $2.2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity.
These book losses are realized if banks have to sell those assets to cover withdrawals from depositors. At the same time banks face challenges in maintaining deposit levels, depositors are less willing to place their money in low-return checking and savings accounts as higher-interest opportunities become increasingly available.
Banks that failed in 2023 have had specific weaknesses that made them particularly vulnerable. Silicon Valley Bank (SVB), for example, was particularly exposed to risk from rising interest rates as it had heavily invested in longer-term government bonds which lost market value as interest rates rose and its management failed to hedge against this risk.
SVB was also especially vulnerable to a run by depositors because over 90% of the value of its deposits exceeded the $250,000 amount guaranteed by the Federal through the Federal Deposit Insurance Corporation (FDIC). Depositors holding accounts in excess of this guaranteed amount, both individuals and companies (whose accounts were used for making payroll, among other reasons) are only partially protected in case of bank failure so they have an incentive to withdraw funds at the first sign of trouble.
Moreover, depositors were connected to each other through business and social groups, so news traveled quickly seeding the conditions for a classic bank run at Twitter speed. Signature Bank also had about 90% of its assets uninsured and its portfolio was heavily concentrated in crypto deposits. Both banks grew rapidly with inadequate risk and liquidity management practices in place and, while regulators had raised concerns about these risks, they had not taken more forceful actions to address them, according to a GAO report. Meanwhile, First Republic Bank, catered to wealthy depositors and for this reason also had a high share of uninsured deposits that made it more vulnerable to a bank run as its bond assets lost value amidst rising interest rates.
Commercial banks reduce lending when their deposits fall or when they otherwise cannot meet regulatory requirements. Deposits represent an important source of banks’ ability to lend. As a bank’s deposits decrease, it has less resources available for lending since other sources of funds are not as easily obtained.
A bank may also cut lending in an effort to satisfy regulations such as meeting or exceeding the Capital Adequacy Ratio. Regulators require banks to have enough capital on reserve to handle a certain amount of loan losses. The Capital Adequacy Ratio decreases when loans fail and the bank sees its loan loss reserves decline. The bank can then increase its Capital Adequacy Ratio by using funds that would otherwise be devoted to commercial loans or by shifting from loans to other assets that are less risky (such as government securities).
There is evidence that this effect contributed to the cutback in bank lending in New England in the 1990-1991 U.S. recession when there was a collapse in that region’s real estate market. A bank may choose to reduce lending if there are concerns about solvency even if it is not yet hitting up against the formal capital adequacy ratio requirement.
A credit crunch occurs when borrowers who would otherwise receive loans are precluded from doing so because of a restriction on the supply of loans by banks. But a reduction in bank lending could also reflect a decrease in borrowers’ demand for loans.
Researchers have used a variety of methods to identify when there is a credit crunch rather than just a lower demand for loans. For example, a credit crunch could be identified through looking for differential borrowing, employment, and performance patterns by bank-dependent companies as compared to those that have access to financing through bond or equity markets. Bank-dependent companies are typically smaller than those that have access to other types of financing.
Credit crunches due to bank distress can undermine investment and economic growth. An early and influential analysis by Ben Bernanke, who went on to chair the Federal Reserve and served during the 2008 Great Financial Crisis, analyzed the effects of bank failures during the Great Depression. He found that bank failures had a particularly strong effect in reducing the amount of borrowing by households, farmers, and small businesses in that period, which contributed to the severity and duration of the Great Depression.
The U.S. banking system has been made more resilient since that time, but there is still evidence of the effect of a credit crunch on regional U.S. economies. The April 2023 IMF Global Financial Stability Report argued that a credit crunch in the United States could reduce lending by 1%, which would lower GDP growth by almost 0.5 percentage points.
Michael Klein is the executive editor of EconoFact. He is the William L. Clayton Professor of International Economic Affairs at The Fletcher School at Tufts University.
This commentary was originally published by EconoFact: Banks, Credit Crunches, and the Economy.
More: Justice Department to weigh updating banking competition rules
Also read: Senators make headway on clawing back pay from failed banks’ CEOs, as key committee advances bill
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Goodbye pandemic refi cash-outs. Hello HELOCs?
Home-equity lines of credit (HELOCs) and second-lien mortgages have been staging a notable comeback as U.S. homeowners look for liquidity and ways to monetize the pandemic surge in home prices, according to BofA Global.
It used to be that borrowers sitting on an estimated $33 trillion pile of equity built up in their homes could simply refinance and pull out cash, until the Federal Reserve’s rapid rate hikes began squelching the option.
Now, with mortgage rates above 6%, and the Fed penciling in two more rate hikes in 2023, cash-strapped homeowners have been seeking out alternatives to extract cash from their properties.
While cash-out refinances tumbled 83% in the fourth quarter of 2022 from a year before, HELOCs rose 7% and home-equity loans grew 31%, according to the latest TransUnion data.
“Borrower demand remains high, particularly given household budgets have been pressured by rising food and energy costs,” a BofA Global credit strategy team led by Pratik Gupta’s, wrote in a weekly client note.
Risky loans to subprime borrowers and home equity products helped precipitate the 2007-2008 global financial crisis and the era’s wave of devastating home foreclosures.
At the time, households had more than $1.2 trillion of home equity revolving and available credit (see chart), whereas the figure was closer to $900 billion in the first quarter of this year.
BofA Global, New York Fed Consumer Credit Panel/Equifax
The pandemic saw home prices surge, giving a big boost to home equity levels. The Urban Institute pegged home equity in the U.S. at $33 trillion as of May, up from a post-2008 peak of about $15 trillion.
BofA analysts argued this time home equity products look different, with roughly $17 trillion of tappable equity across 117 million U.S. homeowners, and most borrowers having high credit scores and low rates.
“The vast majority of that — $14 trillion — is from the cohort of homeowners who own their homes free & clear,” Gupta’s team wrote.
Another $1.6 trillion of equity could be available from Freddie Mac and Fannie Mae borrowers, according to his team, which pegged an estimated 94% of all outstanding U.S. first-lien home mortgages now below 4% rates.
Major banks own the bulk of home equity balances (see chart), led by Bank of America Corp.
BAC,
PNC Bank
PNC,
Wells Fargo,
WFC,
JPMorgan Chase
JPM,
and Citizens
CFG,
according to the team, which notes several other major banks appear to have hit pause on their programs.
A smaller portion of HELOCs and second-lien mortgages have been securitized, or packaged up and sold as bond deals, while nonbank lenders have been offering the products as well.
Stocks closed lower Monday, taking a pause from a recent rally, as investors monitored weekend tumult in Russia. The Dow Jones Industrial Average
DJIA,
was less than 0.1% lower, while the S&P 500 index
SPX,
was off 0.5% and the Nasdaq Composite
COMP,
fell 1.2%, according to FactSet.
Related: The economy was supposed to cave in by now. It hasn’t — and GDP is set to rise again.
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Corporate treasurers plan to put more cash into money market funds rather than deposits, according to a new survey that highlights the pressures banks are facing as they strive to hold onto their customers’ money.
In a survey conducted earlier this spring, 38% of treasurers said they wanted to increase their allocation of cash to money market funds that invest in U.S. government securities, which they saw as a safe place to put money while also earning some interest.
By contrast, 27% of the survey respondents said they were looking to increase their bank deposits. One in four said they were looking to reduce their bank deposits, according to the survey from the Association for Financial Professionals.
Those results could be worrying for bankers, since money market funds compete with deposits, which have declined at many institutions after the banking turmoil in March.
It’s possible that the attitudes of corporate treasurers have changed since the survey was completed. The responses were fielded between March 7, three days before Silicon Valley Bank’s failure, and March 30.
Still, the results suggest some fraying of the ties between banks and their commercial clients, which the industry has traditionally counted on as a source of stability. Some 83% of treasury professionals said their relationship with a bank was critical in picking where they placed deposits, down from 93% last year.
“When something rattles the industry, like we saw in March, they’re looking at it … with a slightly different lens,” said Tom Hunt, director of treasury services and payments at the Association for FInancial Professionals.
Relationships with banks remain important, he said, but treasurers are increasingly wondering: “Where is my risk?”
Companies are already moving more of their cash into short-term investments, primarily by buying Treasury bills or investing in money market funds that buy short-term government securities, the survey found.
Others are still keeping more cash in the banking system — either parking it at larger banks that are viewed as too big to fail or using services that offer workarounds to the Federal Deposit Insurance Corp.’s $250,000 coverage limit.
The Association for Financial Professionals received 222 responses from treasurers and those in similar positions, with 78% of them coming from companies, 13% from nonprofits and 8% from government agencies.
The survey results line up with the deposit churn that banks have been seeing, said Peter Serene, a consultant at Curinos who advises banks on commercial deposits.
Banks are competing heavily for companies’ extra cash, both with each other and with higher-yielding options such as money market funds. Even when an institution is a company’s primary bank — the place where it keeps cash for its daily payments — it may find that it can’t rely on as many funds as it once did.
“Great, you won the primary relationship. But you can’t expect to get quite as many deposits with that as you could have in the past,” Serene said.
The survey results also pointed to some frustration with banks that have sought to keep the rates they pay to commercial depositors low over the last year. As the Federal Reserve hiked short-term rates aggressively, yields on money market funds rose quickly.
The process of getting higher rates at banks is “not as transparent as corporations would like,” according to Hunt of the Association for Financial Professionals. Banks often use one-off exception pricing, and their so-called earnings credit rates can be confusing, he said.
Some corporate deposits technically don’t earn interest, but they do get credits that essentially lower the fees that companies have to pay for the services banks provide.
The survey found that transparency in how those credits work is a critical factor in 19% of treasurers’ decisions on picking a bank, up from 9% last year.
What’s more, the average rate those credits paid in April was just 0.72%, according to Curinos data, compared with more than 2% or 3% on bank corporate deposit and savings accounts, and even higher rates at money market funds. Companies are waking up and doing the math, Curinos’ Serene said.
“And they’re saying: ‘Boy, maybe I should really be changing the way I think about using my cash and use it more to earn interest and less to offset bank fees,” Serene said.
In light of the changing market, some banks are paying interest on what were once non-interest bearing deposits — raising their expenses and hampering their profitability.
Banks are a “critical juncture,” Serene said. They want to keep their rates relatively low, yet they also want to keep their credibility with clients by helping them to earn more.
“The challenge is, when you do that, it’s better for the client. It’s not as good for the bank,” Serene said. “So the bank stands to see their interest expense increase faster than it gets offset with fee income.”
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A major financial services CEO warns the economy hasn’t fully absorbed higher interest rates yet.
Thomas Michaud, who runs Stifel company KBW, notes there’s a delayed reaction in the marketplace from the last hike — calling a 25 basis point move at 5% a very different situation than off a half percent.
“This is getting to be the real deal at the moment because of the level of rates,” he told CNBC’s “Fast Money” on Wednesday. “The bite of these higher rates is gaining traction almost every day.”
Michaud delivered the call hours after the Federal Reserve decided to leave interest rates unchanged. It comes after ten rate hikes in a row.
The Fed signaled on Wednesday two more hikes are ahead this year. Michaud expects one to happen in July. However, he questions whether policymakers will raise rates a second time.
“Trying to deliver a new message with these dots is not what I’m willing to hang my hat on from what I see happening in the economy,” he said. “The economy is slowing. So, I think we’re near the end of this rate increase cycle.”
He lists interest rate sensitive areas of the economy already in a recession: Office space in urban areas, residential mortgage originations and investment banking revenues. He sees the problems contributing to more pain in regional banks.
“Banks were already tightening in the fourth quarter of last year. It didn’t just start in March. Loan growth had been slowing,” added Michaud. “There are elements of like the global financial crisis that are in bank stocks right now.”
According to Michaud, the regional bank rally is a short-term bounce. The SPDR S&P Regional Banking ETF is up almost 18% over the past month.
“The overall industry rally for all participants probably doesn’t happen until we get some more stability in what we think the earnings are going to be,” said Michaud. “Earnings estimates haven’t settled. They haven’t stopped going down.”
He sees a shift from adjusting to the new interest rate environment to credit quality in the second half of this year.
“Before the first quarter we cut bank estimates by 11%. After the quarter, we cut them by 4%.” Michaud said. “My instincts are we are going to cut them again.”
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Mediterranean fast-casual restaurant chain Cava Group on Wednesday priced its initial public offering of 14.4 million shares at $22 a share, up from a prior range, giving the company a valuation of roughly $2.45 billion.
Shares are expected to begin trading Thursday on the New York Stock Exchange with the ticker symbol CAVA.
The rapidly-growing…
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Is America going into a recession or not? That depends on who you ask—and how old they are.
Consumer households from their 20s to their 50s are now spending sharply less on their credit and debit cards than they were a year ago reports Bank of America, after crunching the numbers on its customers.
At this point it’s mostly those over 60, and…
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UBS said Friday that it’s signed a loss protection agreement with the Swiss government covering up to 9 billion francs ($10 billion) of losses once the takeover of Credit Suisse is completed.
The finalized deal sets the stage for the merger of the Swiss banks to be completed as early as June 12.
Terms call for the guarantee to only be implemented if UBS takes 5 billion francs of losses from what are called non-core assets of Credit Suisse.
The protection applies to roughly 3% of the combined assets of the merged bank. UBS is paying the Swiss government an upfront fee of 40 million francs, as well as an annual maintenance fee of 0.4% and a risk premium depending on how much of the guarantee is used. UBS does have the right to terminate the guarantee at any time.
The per-share value of the UBS offer
UBS,
UBSG,
has climbed slightly since the deal was first announced, as it’s now worth 0.81 francs per share, valuing Credit Suisse at 3.2 billion francs, or $3.6 billion.
UBS agreed to buy its rival for an initially announced 3 billion francs after Credit Suisse
CS,
CSGN,
was unable to stem outflows from its wealthy clients.
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By Pierre Bertrand
UBS Group said it expects to complete its acquisition of Credit Suisse Group and have the shares of the Swiss peer delisted as early as next week.
Upon completion, Credit Suisse will be merged into UBS and its shares and American depositary shares will be delisted from the SIX Swiss Exchange and the New York Stock Exchange, UBS said in a statement Monday.
If the acquisition is finalized before the opening of trading in the U.S. on June 12, Credit Suisse will de delisted in New York on June 12 and delisted in Switzerland on June 13, UBS said.
If the deal is finalized after the opening of trading in the U.S. on June 12, the delisting on the NYSE and the SIX will both occur on June 13, UBS added.
UBS, which received the European Union’s clearance for its takeover of Credit Suisse last month, said Credit Suisse shareholders will receive one UBS share for every 22.48 outstanding shares held and that it will assume all Credit Suisse Group assets and liabilities.
It added that Credit Suisse Group’s obligations under its outstanding debt securities will become UBS obligations.
UBS agreed to take over Credit Suisse as part of an emergency measure in March to shore up the troubled lender and restore confidence in the global banking system.
Write to Pierre Bertrand at pierre.bertrand@wsj.com
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