State of US Banks — Dec 2023

The OCC released their semi-annual report, Semiannual Risk Perspective for Fall 2023 last week on the state of the banking industry in the US and notes that state of banking industry remains sound but challenged while the economic headwinds are receding due to strong consumer spending, strength in labor market and resilient corporate profits. However the report highlights challenges that inflation remains above long term goal (2%); job growth is slowing and warns that consumer savings have been depleted due to strong spending and end of pandemic assistance. Some interesting nuggets from the report;

State of Banks

• Return on equity (ROE) for banks increased to 13 percent from around 11 percent in 2022 driven by strong growth in net interest income (NII) which increased by 21% from a year back but the challenges of decreased valuation, higher funding and deposit costs and weak demand for loans and IPO’s weigh heavily on future outlook.
• Along with NII, the cost of funding has increased along with increased deposit outflows as consumer pulled cash out from bank to seek yield elsewhere (money market funds). As a result uninsured deposits as a share of the total liabilities of the the banks fell from 45% to 40% year over year while non-deposit liabilities (which have higher cost of funding) increased to 12% compared to a year back from 10%. Bank Funding risks were also noted as one of the key risks to the U.S. Financial system in the FRB’s Financial Stability Report from Oct 2023.
• Loan growth has peaked since mid-2022 driven by weakness in Commercial and Industrial loans (C&I) and CRE loans and more than half of the banks reported weak demand and tightening condition in both sectors. This along with a weakened IPO market is hurting the profitability of the banks.

Key risks highlighted in the report are;

• Credit Risk — risks are highest in CRE and specifically in the office sector and the new office leases are reflecting smaller footprints post Covid. There is a bifurcation happening with 5 star and newer office buildings remaining more resilient compared to older buildings. Retail and other businesses in urban areas that depend on foot traffic are also showing more vacancies. Other area where risk is increasing is multi-family housing due to higher inventory and low demand. Credit card and auto delinquencies increased in most banks in 2023 and retail net charge-offs driven by credit cards, have increased steadily each quarter for the past year. However the charge-off’s and delinquencies are in line with long term averages before pandemic showing that savings from pandemic assistance are now depleted. The resumption of student loan payments in Oct will add more stress to the wallets of the average consumer which is reflected in the downward dip in chart below at right indicating increasing negative consumer sentiment from University of Michigan survey from past month.

• Market Risk — the key risks are driven by the higher rate environment not surprisingly. Higher rates have increased funding costs as noted above for banks and risks include unreliable modelling of deposit assumptions which may result in higher-than-forecast funding costs, unexpected liquidity shortfalls, and imprecision in balance sheet hedging. Due to increase in 10Y Treasury yield which reached their highest level in 15 years in November as shown below, banks have accumulated losses in Available for Sale (AFS) and Held to Maturity portfolios which have significant holding of Treasuries; this was one of the main drivers behind bank failures in spring 2023. The report notes that currently, unrealized losses in the AFS portfolios remain elevated at 8% while unrealized losses in HTM portfolios increased to 16% and so this will continue to a key indicator to watch to gauge state of the banks………..watch this space!!!

Originally published at http://just-random-thoughts.blog on December 16, 2023.