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Daily Intelligence Briefing

Wednesday, September 13, 2023

Identifying Change-Driven Investment Themes

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Bank Deposits Show No Sign of Rebound, Rising Credit Rejection Rates Could Crunch Profits

Summary: US bank deposits dipped to their lowest level since May in the most recent week of data, signaling that a meaningful rebound in banks’ cheapest source of funding might still be far off. Reliance on brokered deposits and government-backed funding from the Bank Term Funding Program (BTFP) continue to grind higher with rates elevated and unrealized losses having re-expanded.


Though lending dynamics have improved with a steepening of the yield curve, survey data shows that banks appear to be tightening credit standards and raising rejection rates to levels unseen since 2018. Banks feasted on record issuance of new credit cards early in the year, but growth in consumer credit has slowed significantly over the past several months, potentially impacting net income going forward.


Related ETFs: SPDR S&P Bank ETF (KBE), SPDR S&P Regional Banking ETF (KRE)

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Deposits held across all US commercial banks dipped to a nearly four-month low in the final week of August. The outflow of more than -$70.1 billion during that period was the largest since July. Since peaking in April 2022, the US banking sector saw total deposits at all commercial banks decline by as much as -$981.0 billion. Since that trough, only about 3.7% of withdrawn deposits have returned to the banking system. 


The value of the funds on loan from Fed’s Bank Term Funding Program jumped to a record high of more than $107.9 billion in the week to September 6, up by almost 7.7% over the past three months. The BTFP allows banks to take advances from the Federal Reserve as a loan for up to a year by pledging their underperforming Treasuries, mortgage-backed bonds and other discounted debt as collateral at par value. Not only is the liquidity significantly more valuable than the collateral backing it, but also very expensive for banks, with the most recent effective rate of that debt coming in at more than 5.5%. When the BTFP was established, the US Treasury Department pledged to backstop the program with $25 billion, but its current level of lending is doling out more than 4x that amount.


As MRP has previously noted, the rise in BTFP borrowing has helped to partially offset some of the decline that was witnessed in banks’ reliance on 11 government-sponsored wholesale regional lenders known collectively as the Federal Home Loan Banks (FHLB). The Financial Times writes that US banks and credit unions had $880 billion in outstanding loans at the end of June from the entities, down roughly -$120 billion from an all-time high just north of $1 trillion in Q1, but the increase in BTFP lending over that same period was equivalent to almost $38.7 billion. That cuts the net decline in reliance on government-backed financing (excluding credit extended through the discount window and lending to bridge banks) to less than -$81.3 billion. Much like the interest on BTFP loans, the one-year rate on a regular fixed rate advance from the Boston FHLB is currently equivalent to 5.5%.


In addition to massive advances from the BTFP facility and FHLB system, banks’ dependence on brokered deposits, high interest accounts sold to a bank by a third-party broker, is also on the rise. According to Wall Street Journal reporting, US banks collectively held more than $1.2 trillion in brokered deposits in Q2, an 86% increase YoY. As MRP wrote in August, the credit ratings of fourteen banks with over $900 billion in consolidated assets were downgraded by either Moody’s or S&P last month. The two largest institutions among the cohort of downgraded banks were M&T Bank and KeyCorp (the owner of KeyBank), which each more than doubled their holdings of brokered deposits over the last year. Though brokered deposits only made up a small share of their overall deposits, several smaller banks with less than $100 billion in assets like Associated Banc-Corp and Valley National Bancorp (both of which were also subject to recent credit ratings downgrades) saw brokered deposits rise to more than 10.0% of all domestic deposits held at the banks.


A persistent dearth in deposit growth has shaken confidence in bank shares, represented by the SPDR S&P Bank ETF (KBE) and SPDR S&P Regional Banking ETF (KRE), which have now fallen -6.8% and -8.7% over the last month, respectively. Banks have also witnessed a recent resurgence in unrealized losses, which expanded by -$42.9 billion to -$558.4 billion in Q2. That paper loss is significantly narrower than the -$620.4 billion reported in the fourth quarter of 2022, but rates have continued to climb to new highs in the current quarter, putting greater stress on banks with significant holdings of long-dated Treasuries and mortgage-backed securities, acquired when interest rates were much lower than they are today (and bond prices much higher). Yields on 10-year US Treasury bonds jumped to a near 16-year high in August, north of 4.35%, and remain elevated near those levels today. Though that rise will likely continue to exacerbate the unrealized losses on many banks’ Treasury and mortgage bond portfolios, it has managed to help repair the dynamics of banks’ lending business by steepening the yield curve.


Still, net income for the 4,645 FDIC-insured commercial banks and savings institutions in the US declined by -$9.0 billion (-11.3%) QoQ to $70.8 billion in Q2. Those profits could be crunched further by the onset of tighter lending requirements. Per US Fed data, the cumulative addition of new US consumer credit over the past three months was equivalent to just $24.4 billion, the smallest 3-month sum since the end of 2020. Big banks pulled in huge amounts of revenue early this year by raising limits on many credit card accounts and issuing a record $89 billion worth of new credit-cards in the first quarter, but the average rate on credit card plans has now soared to an all-time high of almost 20.7%.


Not only should high rates slam demand for credit, but they have also begun cutting off the supply of credit as well. A New York Fed survey released this week showed the overall rejection rate for credit applicants increased to 21.8%, the highest level recorded since June 2018. Though rejections rose across the board for everything from mortgages to auto loans, the rejection rate for credit card and credit card limit increase applicants were 21.5% and 30.7%, respectively.


The Fed’s quarterly Senior Loan Officer Opinion Survey (SLOOS), released in July showed US banks reporting tighter credit standards and weaker loan demand from both businesses and consumers throughout Q2. In particular, significant net shares of banks reported having tightened standards for credit card loans and other consumer loans. About half of US banks are now tightening their standards on commercial and industrial (C&I) loans for small, medium, and large businesses alike. A larger portion of the banks, north of 60.0%, note that the cost of their credit lines and premiums charged on riskier loans are both tightening for businesses of all sizes.


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