What a ride it's been for the banking sector recently. Three banks have collapsed, with one choosing to wind down its operations and liquidate its assets, while the other two -- Signature Bank and Silicon Valley Bank, part of SVB Financial -- were taken into receivership by the Federal Deposit Insurance Corp. (FDIC). And don't forget about Credit Suisse, which recently was forced into an acquisition by Swiss banking regulators after it looked like the bank was about to collapse as well.
In two days, JPMorgan Chase will kick off bank earnings season, and I can't think of a more important time for the sector except for the very beginning of the pandemic or the Great Recession. Here are the three most pressing questions for banks as we enter earnings season.
Image source: Getty Images.
1. Deposits, deposits, and more deposits
Considering that both SVB and Signature experienced significant deposit runs and other banks like First Republic have seen significant outflows as well, the biggest questions heading into earnings season by far are about deposits. How much in deposit outflows did banks experience? And how much higher are bank deposit costs? Both will have a huge impact on Q1 earnings and earnings estimates moving forward because deposit costs are a big part of bank margins.
I fully expect banks to have experienced deposit outflows, and I also expect their deposit costs to rise materially. The recent failures of several banks have put consumers and businesses on edge about how safe their money above the $250,000 insured limit is. Also, U.S. Treasury bills and certificates of deposit are yielding an attractive risk-free 4% to 5%, and the Fed has also been pulling liquidity out of the economy through quantitative tightening.
Already, we know from Federal Reserve data that all U.S. commercial banks have seen roughly $412 billion of deposits flow out of the banking system in March on a seasonally adjusted basis, although outflows have been slowing. The top 25 U.S. banks saw about $63 billion of outflows in March, while smaller U.S. banks saw $235 billion. However, outflows have stabilized at these smaller banks more recently.
To get an idea of a specific bank's outflows, you'll want to check how much lower-cost non-interest-bearing and interest-bearing deposits declined in Q1 and how much higher-cost deposits such as borrowings rose to replace the outflows.
I'm also very curious to hear more anecdotal information from bank management teams on what kinds of depositors have been the most stable since the banking crisis started. I suspect that smaller-dollar checking accounts have held up the best in the universe of cheap deposits, but are there other types of depositors that have been more stable? How about certain geographies?
What are the trends being seen among business customers with balances at a bank exceeding the $250,000 insured amount by the FDIC? Banks with higher-cost deposit bases may end up being less volatile this year because the higher-cost deposits are already an inherent part of their model, and deposits may be locked in for a certain period of time.
Finally, I'm very curious about how much cash banks are planning to hold in the near future. With uninsured deposits a concern, I suspect banks are going to plan to keep more liquidity right now. The reason this is important is that holding cash can hurt bank profitability.
2. Plans for bond portfolios
Deposit outflows have proven dangerous because banks heavily invested in bonds during the ultra-low-interest rate environment seen in 2020 and 2021. These bond portfolios have been crushed by rising interest rates and are now underwater. SVB's bond portfolio was so underwater that it would have wiped out all the bank's equity, had the bank needed to sell them to cover deposit outflows.
Banks should see some reprieve because the yield on the U.S. 10-year Treasury note fell about 40 basis points (0.40%) during the first quarter. Still, the S&P 500 U.S. Mortgage-Backed Securities (MBS) Index didn't change all that much in Q1, and many banks invested more heavily in MBS than Treasuries, so a good amount of that is still likely underwater. We know from a recent update from Western Alliance Bancorp that the bank saw its unrealized bond losses fall in Q1 by about 12%.
In addition to getting an updated unrealized loss figure, investors and analysts will likely be interested in how management teams are thinking about securities purchases going forward and what they can do to reposition their balance sheets, if anything. I'm guessing most banks are still going to have to wait for yields to come down, and I expect most new bond purchases will be put into shorter-duration securities. Perhaps management teams will also consider selling securities if they can do so without incurring a material loss.
3. Credit quality
Another big thing that investors have really honed in on since the banking crisis began in March is credit quality among their consumer and commercial real estate portfolios. Consumers have been spending down their savings ever since the economy began to normalize following the pandemic, thanks to some of the highest levels of inflation seen in 40 years. While the personal savings rate has come down, consumers are still believed to have more overall excess savings than prior to the pandemic.
Investors are also worried that there is a storm brewing in commercial real estate, specifically in the office, multifamily, and retail segments. Credit quality, in general, has been squeaky clean over the last few years but is certainly going to deteriorate, especially if there is a recession. The commercial real estate picture will become more clear as time progresses and more leases and loans come due.
Currently, I'm not expecting to see any huge blemishes in Q1 earnings because credit was still very healthy after Q4, and it takes some time for deterioration to occur. Also, banks are now expected to tighten credit quality to preserve liquidity. That said, banks may raise their provisions for loan losses to prepare for a more difficult economic outlook later this year.
