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By Jeffrey Cohen, Investment Advisor Representative
US Advanced Computing Infrastructure, Inc.
Here is our initial, brief read on the US macroeconomic situation and the top banks generally.
We saw deposits were weak, either because people are moving money to gain yield, or because they are spending their savings. We saw loans rising, most likely because they are now more profitable for banks. More loan volume across the board. Net Interest Income was significantly higher in Q4/2022 than for the prior quarters of the year, and prior years. Bankers said to be cautious to extrapolate Q4 into 2023, and expect 2023 Net Interest to be less than 4x 2022/Q4. Most of the bankers have hedged or swapped out their asset sensitivity to low rates, or are consciously working through yield, duration and maturities to limit the impacts. Most bankers were happy to be investing at 3.5% when long bonds a year ago yielded much less. There was significant less asset management and investment management fee revenue across the board. Assets under management (AUM) was weaker due to weak equities and bond markets. Also, there was little if any IPOs, Venture Capital spin outs, mergers and acquisitions, and likely (not mentioned) underwriting of new debt. This was a weak spot for all banks. However, all four were investing in their asset management teams of people. Net Charge-offs rose for all banks, and were rising, but still below pre-pandemic levels. We saw reduced credit quality in the consumer space, or what we called credit risk weakening. All the banks had higher expenses. Some of the banks saw or expected increases in their operating leverage, while others did not. It did not matter, all banks were increasing their non-interest expenses. The banks had various forecasts of the macro-economic and monetary policy situation in 2023. They all expected interest rates to rise in 2023, but the size of the raise was smaller. I seem to remember 0.75% or 75 basis points was a typical rise for 2023. The banks also expected a softening economy or light recession. I am trying to remember, but I think $JPM suggested unemployment would rise to 5.5%. We also tweeted it out.
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We ran the numbers based on Dec 30, 2022 market close data for indices on US Treasuries and MBS securities (UMBS 5.0). The analysis will be re-confirmed this week with a fresh set of eyes. It assumes that CFR did not buy any new investments in Q4 (we use Q3 investments to do our valuations).
Cullen Frost gained value on their investments, which means they likely will have positive AOCI. We guess their bets on buying long assets with short money will pay small, but positive dividends in Q4/2022. We assume that CFR did not buy swaps to protect themselves against rising interest rates in Q4, as those would likely expire out of the money, and cost the bank the premium. The gains were especially large in the residential mortgage-backed securities (RMBS) they hold. This trend was quite negative and dramatic in Q2 and Q3 while interest rates were rising. However, rates fell into year-end and this will help the capital position for US regional banks, like Cullen Frost. GLTA CET1: up 0.5% Net charge-offs improved Efficiency ratio: down to 62% in Q3 from 67# in Q2. We run the bank with fewer people than in 2015. Consumer banking is increasing (number of accounts). Significant organic growth with the bank. Merrill Lynch accounts are moving digital. Sales and trading (global markets) up 13% YoY, with no trading loss days in Q3. Wow. Consumers continue to spend more, strong spending. Consumer deposits are very strong, up 2x to 5x over pre-pandemic levels. Payments on credit cards are up significantly. YTD spending of $3.1T is up 12% YoY, with growth in Gas (23%), Travel & Entertainment (20%), Food (10%), Services (9%) and Retail (3%). Early to late stage card delinquencies are at decade level lows. 1.38% 30+ days past due. However, the last quarter is up in all categories. Is this the beginning of the trend higher for credit card past due amounts?  This is a strong quarter. They even bought back $450M of common stock.
I notice that assets and investments both declined about $50B in Q3. Shareholder equity is constant at $240B Stress capital buffer increased the requirement from 9.5% to 10.5% for CET1. They are at 11.0%, which is 0.5% above required level. 11.4% by January 2024 is the increased requirement. Significant hedges in place protect the bank: AOCI declines on AFS investments down $1.1B. Overall AOCI declined $4.4B due to increased interest rates. Significant loss from derivatives (~$3.1B) to protect AOCI losses. Delayed SWAP starts. Forward-starting SWAPs, which should pay in Q4 and a little in Q1/23. Good commercial loan demand. Sold / syndicated some of their business loans and mortgages (~$1.1B) to reduce their RWA. This looks like good stewardship. Confirmed, not big but a step in the right direction to reduce RWA. Rolling off corporate bonds / loans and replace with UST, which further improves RWA and increases yields too. Consumer deposits up 7% YoY. $1.1T Total Corporation deposits down 3%, to $1.96T. Global Wealth Management and Global Banking declined in deposits. NII (GAAP) $13.9B Net interest yield: 2.06% Customer cost of deposits: 0.03% Consumer credit card risk-adjusted margin 10.07% Excluding global markets, net interest yield 2.51%. Mortgage rate yields are up even higher than deposits. 100bps up in interest rate across yield curve benefits $4.2B over 12 months. This assumes market based rates, deposits down slightly, and activity adjusting as expected. $1.3B rise in NII in Q3, supports the expected growth in profitability. Efficiency Ratio 62% for the bank Efficiency ratio for the consumer bank: 51% (which is more in line with a monoline retail bank). Headcount up 5,000 this quarter.Non-interest expenses are flat since 1Q/22. Wow, why are non-interest expenses flat? No inflation impact. Mgmt stated it was discipline around expenses, and modest investments in the company. Consumer bank expenses up 11% in non-interest expenses, including bank renovations. Biggest impact of inflation. Digital banking and operational process improvements help. Net charge offs 0.20% for a total of $520MM. Provision for credit losses $898MM, which increases the cushion. Consumer delinquencies are lower than normal. Commercial net charge offs are flat, 0.04%, which is almost zero. Wealth Management This is the first time since 1976 that both bonds and equities markets were down for the year at the same time, assuming markets end where they are now. (34 minutes). Earnings of $1.2B is strong given the weakness of the overall market. Global banking Earnings are down 20%, but still strong at 2.03B. Bank rates #3 in global banking. Adding to the reserves here of $144MM. Global Markets, excluding DVA. Earnings: Sales and trading were strong, FICC was strong, equities weaker, and global markets investment banking down almost 50%. 10% return on allocated capital for this business. Inflation reduction act: Solar energy investments to select production tax credits vs. old way. There was $150M in tax claw-backs in the short term, but should increase tax credits over the life of the solar investments. Tax rate would have been 24% ignoring special items like solar and ESG. Q&A Securities run-off at about $15B/quarter. This quarter ran off a little faster, and there were profitable offsets in Q3. Expense growth, single digits and will see better operating leverage (at some point, a 1% to 2% rise). Non interest expenses have been running $15.3B / Q for the past three quarters with a little 'stuff' in each one. That run rate will hold. Consumer deposit strength based on the value proposition for clients to be their full service operational / transaction provider. This is why we see so many non-interest accounts. The services are the value proposition. AOCI: UST duration between 4-5 years MBS 7-8 year duration Derivatives: some of those It will be faster for any securities that get repaid earlier. What about recent rises in credit costs? Origination backward-looking looks good. Normalization to pre-pandemic levels occuring. Auto business down 1/2 on a monthly basis. They built a durable consumer book. Lower risk lending. Commercial book upgrades and downgrades. $400M in reserves, and the Net charge offs are about level. Reserves baking in a recession, but the numbers are so low, squinting to see a change here in credit quality. "Squinting" Second best numbers all-time. Good morning...our bank earnings call reviews continue.
Slowing global growth. Rolling, country-level recessions starting in this quarter. Inflation causing global reduction in consumer demand. Europe is the highest warning. US market looks strong. Inflation fighting will take time and strong actions, through second half of 2023. Asia: concerned with COVID lockdowns. Geopolitical risks and rates dominate client discussions. Counterparty risk vs. credit risk. Impressive reserves of about 2.5% funded loans. CET1 equity levels are equal to regulatory requirements, at 12.2%. Citigroup benefits from spinning off global consumer business. Stock buybacks at 13%? Asked by an analyst. Mile-markers: Net interest income is strong (seems in line or slightly lower than other banks in Q3. Non-interest revenue is down significantly. Credit costs BETA levels are increasing, but lower than expected. This is driven by mix of business towards institutional and operational / corporate, as opposed to retail BETAs which are lower. Interesting to see that average loans and deposits are both down 2%. Also surprising to see cost of interest-bearing deposits up in Q2/22 0.53% to Q3/22 1.21%. This is a significant gain. Reducing (slightly) risk-weighted assets (RWA) by exits and asks for greater collateral from investors. Interesting to see this massive bank look to reduce market exposure. Should be confirmed, as this is material. Net-Net, in Q4, Citigroup expects net interest income to rise, non-interest income to fall, and non-interest expenses to increase by 9%. When will revenue growth exceed expense growth? These are multi-year investments, and in years, we should get to an operating ratio below 60%. No direct answer, but it will take years to see revenue growth cover expense growth. As we listen to the earnings call, here is what we are learning.
Net interest margin increased 32 basis points, which is a record for many years. Credit quality is unchanged over the quarter. Capital strong, and returned $1.7B to shareholders through common dividends and share buy-backs. PNC, a national, main-street bank. They borrowed more from the Federal Home Loan Bank, up by $8B in the quarter. CET1 ratio is 9.3%. Higher mortgage loans and credit card balances, offset by automotive loan decreases (overall up $1.5B of consumer loans). Credit cards usage is up. That is good for them. They just raise prices as risk raises, but don't change credit availability. They lend to the higher levels of credit (investment grade for corporates and prime for consumer). Consumer deposits down 2%, or -$4.3B. 68% interest bearing. Commercial deposits grew at the end of the quarter. So far in Q4, deposits are increasing but expect stable to down a bit. Stable to down in consumer, and consumers are spending more. Inflationary pressures. Interest costs increased. Cumulative BETA Q3 is 22%, will rise to 30% by year-end. Deposit BETAs. Securities grew and yield increased to 2.21% or 21 bp. 80% of purchases directly into HTM, 66.4% overall HTM. AFS is 33.6%. AOCI -$10.5B. They expect those values to fully accrete back per year, or 5% per quarter. Ouch. They use derivatives, and made $13M this quarter, but lost $16m last quarters. They are reducing operating costs to fund internal investments (e.g., technology). Provision for credit losses: $241M to account for uncertain economic outlooks. Delinquencies increased by 8%, but many are being resolved. Net charge offs, 15 bps, are at historical lows. Very strong credit quality metrics. Total reserves are 1.67% of total loans. They expect 125bps raise by the FED FOMC, 75bps in October and 50bps in December. Q&A Begins: Buybacks came in higher than the $750M planned for Q3. Active repurchase event underway. Following BBVA acquisition, they are expecting to average $700M to $750M in Q4 share buybacks. NII: It is somewhat self-evident. NII goes up as interest rates are raised by the FED. Loans will earn more, and deposits cost more too. When the FED is done, they increase rates on deposits (BETA). The roll-down of securities (as they mature), and we can reinvest at higher yields. What about swaps on rates? What happens to the high end of the rates schedule (as they grow)? Can NII continue to grow in Q4? Capital dropped $4B to $5B. Flat to more asset sensitive due to rates. We let things roll off, replaced them, but not added. Letting things roll-down (4.6 year duration). Duration of the swap book is 2.3 years. Current investments: 4.6 year duration. Rates from one handle to 4.5 plus. We are much more exposed to 'down rates' than we are to 'up rates.' They limited investments with swaps and bonds. They are more worried about down rates, because they make more money as rates rise. They have capacity to buy more assets, but are not yet. Waiting to see what happens. More asset sensitive. Why go asset sensitive for the last 6 months? Arguments with the economics team. We would need much higher rates to fight inflation. Don't buy anything when you know rates are rising. It's obvious. Consumer money is stickier than expected is the answer to why are deposit BETAs better than everyone modeled? Corporate and money markets are doing what is expected, but consumer money is sticky. Repricing is stickier and slower than everyone assumes. Back of the curve will sell off. They go negative in 3 months on rates. If the FED stops, and inflation keeps going (low 3s and sticks there), then the long bonds will sell off more. Deposits gathered through Covid sticky? Following the flood of liquidity into the system, we will see it recede. They see the shift towards interest-bearing. 33% non-interest bearing and 66% interest-bearing. Bank executives perplexed why the FED would want to add additional 'too big to fail' oversight to the US regional banks. Not necessary, these are not systemically risky companies. More loans, growth in usage of credit lines. Strong consumer credit card spending activity and slower payment rates on credit cards.
Allowances for credit losses are 1.88% oif period end loans. $200M addition to allowances for credit losses due to increased volume of loans, and uncertainty of the economic environment. 11.3% increase QoQ and 20.6% growth YoY for net interest income. NII growth into Q4 and beyond it. Probably the pace of growth changes in the industry, as deposit BETAs changing, loan growth rates are strong, may not stay as strong, as we move forward through time. Net interest margin in Q3: 2.83% Efficiency Ratio: 57.5% Loan balances are up 3.9% for Q3 (over Q2). Average balance deposits (average): Up 2.1%. Declines in mortgage revenues and payment services and treasury management fees. Lower refinancing volumes. Payment services fees dropped slightly, due to pre-paid card volume declines (e.g., benefit cards) as they they are more profitable for banks. Payments revenues (current and forward): credit cards shifted, but fairly strong level of spend (up 10% YoY and up 30% since Pandemic). FX rate on the pound hurt them. Mix of categories is consistent, from hard goods to services, and to non-discretionary from discretionary. Overall levels are still strong. Historically, consumer deposits increased over time for the past 2 years, and now they are stable, not shrinking dramatically for the past 2 quarters. They are now flat for Q2 and down modestly in Q3. Expect a moderation of spend, but not seeing it yet. Payments revenue growth of high single digits for 2023. Still realistic. Volumes strong, but there is a spend shift (but didn't say where). Inflation should raise the amount of purchases even if the volume drops. Trust deposits are up, and are now 15% of our base. Consumer doing ok. Deposit BETAs are 30% in Q3, up from 20% in Q2, and we expect mid-high 30s in Q4. As rates rise, and the FED is more competitive, we expect to see mid-30s%, more conversion to interest bearing. FX impacts out of the UK, and volatility, hurt their merchant revenues. Expenses increased 1.9% QoQ and 4.8% year over year, excluding notable items like preparing for a merger. Forward Looking Guidance for 2022 (Q4 and Full Year 2022): Revenue to increase 5% to 6% in 2022 over 2021. Core expenses up ~2% Reduce non-interest income. Taxable rate to be around 22% to 23%. Fee revenue will be lower, but net interest income will be higher. Credit quality will stay low this year, but should trend higher to historical norms over time. Basel III Standardized Approach
These numbers came from the executive discussion during the call:
Acquisition of Mitsubishi retail should be positive and provide a 20% return on equity. Acquisition at scale in their core markets. Less synergies than expected, but earnings should be same. Accretion of mark to market levels (guided in the past). What does that mean? 40% to 50% accretion levels. Not changing guidance on the acquisition. Manage the balance sheet in a very prudent way. Higher profit relationships. CAT2 by end of 2024 (up to $1T in deposits). They should hit about $800B after the acquisition. Credit is benign. No early stage warning signs. Worried about the future. Economic slowdown driven by lower confidence levels and reduced spending by consumers and business. Prudently manage equity, capital and growth. Balance sheet is strong. Manage the company for the long term. Tech infrastructure was invested in...but now positive operating leverage should grow. Focus on the acquisition, and no guidance on operating leverage growth. Thank you to our employees. Questions on capital structure: CET: 8.3% Widening of the interest rate mark. Looked at 50 bps mark up. Masking on the buy side. 100bps lower than what you are giving us. How is the street getting the math wrong, hedges, or something in the deal protecting UBS. Interest rate moves should be hitting them much harder. Acquisition: Make Whole Agreement to make whole available for sale securities. Also, assumptions on the duration of the AFS / HTM portfolio. Also, manage the portfolio prudently. $6.25B of tangible assets. Make whole provision on investments, but not necessarily on loans. Interest rate marks. Loan portfolio quality overall (slightly better, they think). Mark to market final impacts will depend on many things. 53% HTM vs. 47% AFS, and about 6% of their securities are not impacted by interest rates. They moved some securities in late July as rates dipped. Depositors will move from non-interest bearing to interest-bearing as quantitative tightening continues, and interest rates rise. They work on this and maintaining operating balances (e.g., company uses of cash). $130B balances of money market funds. It's a pricing decision whether to bring them on/off balance sheet, and consumer choices. Residential mortgage business. Gain on sale margins lower. Still excess capacity in the mortgage origination business. Servicing margins dropping too. Gain on sale was down in Q3 (half driven by mix of correspondent and retail origination) and the rest is type/mix of loans. CRE: important business for us. Large corporate REITS (saw some growth). Homebuilders are pulling back, withdrawing from projects. Middle market CRE pricing still pretty competitive, but extending terms. Pressure in the middle market space. Portfolio duration is a little over 5 years. AOCI can be modeled that way. Little longer than 5-year period. Restructuring the books options? Might remix the securities portfolio, e.g., increasing HTM. So much data in these earnings calls and earnings presentations.
Overall observations: - JPM went through their results quickly, and painted a happy, confident story of a bank with many sources of profit that is doing well. There is nothing to worry about, everything is fine. We have headwinds, but they are under control. In a Q&A, Jamie Dimon answered that our reserves are the same in Q3 as Q2 because we already knew about the headwinds and took action. Mr. Dimon had such confidence when he said that the bank is selling weak assets and buying strong ones (example being Ginnie Mae mortgage securities where the mortgages were sold for 2% or 2.5% and buying ones where the mortgages were sold at 5% or 5.5%. They are 'making money' by being flexible, although they wrote off about $1B from sales of US Treasuries and Mortgage Backed Securities in the quarter. They say that for every 1% rise in interest rates, they lose $4B in capital (in AOCI). JPM is a diversified bank, with strong commercial banking, asset and wealth management, and investment banking. JPM bought Bear Stearns, and has a settlement and prime brokerage business. They have Northeast and Midwest depositors in strength. - WFC is discussing their business in more detail. Every business has headwinds. The recession is already coming to the WFC customer. Deposits are down, loan balances are down, late and delinquencies are up slightly, and things are soft. Consumers are spending more, and saving less. This is a tale of a bank cost cutting their way to keep up with softening business. By one example, loan originations in mortgages are down ~25% to the lowest level since 2007, as mortgage rates are up 300bps, or 3%. They are reducing their mortgage capacity to match reduced demand. So, maybe the typical JPM customer is better equipped to survive this economic climate? Maybe the mix of investment and commercial businesses are just better, stronger and more sophisticated than WFC? Possibly true, as WFC is truly a bank (a collection of large regional banks stitched together) and not an investment bank. This bank is telling a tale of woe for the American consumer, that they are spending faster than they are earning. As a reminder, Wells Fargo has a large base of depositors in California. One note: AOCI will take years to earn back once interest rates stop rising. They will take a while. They traded out some MBS for GNMA to get better treatment (a little bit of repositioning). Not at big sizes now or in the future. Commercial real estate: Business is growing for Wells Fargo. Loan balances are up. Growth in multi-family and some industrial properties. New multi-family housing starts are up and growing. The performance of the portfolio is solid, but uncertain. Those property types most impacted by the Pandemic are back to normal. Future OPEX is uncertain. |
Jeffrey CohenInvestment advisor representative & father of six. ArchivesCategories |
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