Source: CICC Monetary and Financial Research
Authors: Yan Jiahui, Hou Dekai, etc.
After the SVB incident in March, the market continued to pay attention to US financial risks, including bank savings pressure, investment losses, liquidity risk, and asset quality.Recently, the four major US banks released 1Q23 results one after another. Revenue and profits all exceeded market expectations, and stock prices performed well after the results were released.
We believe that the time when the market was most concerned about the financial risks of the US is over, and the rapid and responsive treatment of the US government departments has effectively mitigated the spread of panic.
Looking ahead, we expect that the high interest rate environment that continues to exist under inflation will continue to put pressure on deposit and loan growth. The tightening of credit margins raises concerns about risks in local sectors. Therefore, differences in debt capacity and risk control capabilities will lead to differentiation in the US banking industry. We continue to pay attention to the 1Q23 performance release of small and medium-sized banks.
1.Track recent liquidity and credit conditions in the US banking industry
Liquidity pressure in the US banking sector has abated significantly
The decline in the balance of the Federal Reserve's financing instruments reflects improved liquidity conditions in the banking sector.On the debt side, in addition to deposits, we believe that Bank of America mainly obtains short-term liquidity through the following three channels:
1) The Federal Reserve's primary credit window (Primary Credit), that is, the liquidity instrument set up by the Federal Reserve to guarantee the liquidity of commercial banks and the smooth investment of credit to residents and enterprises, was the main way for the banking industry to obtain short-term liquidity from the Federal Reserve before BTFP was established;
2) Bank Regular Financing Plan (BTFP), established by the Federal Reserve after the Silicon Valley Bank incident to ensure that banks can meet depositors' withdrawal needs. Unlike the discount window, BTFP uses the face value of collateral and has no discount rate (haircuts);
3) Federal Home Loan Bank Advances (FHLB Advances). FHLB can provide advances to its member institutions for 1 day to 30 years to meet their short and long-term liquidity needs.
The balance of the discount window has narrowed markedly in recent weeks, mainly due to the substitution effect of BTFP. We think the reason may be that BTFP's interest rate level is lower than the discount window and is valued at face value without a discount, making financing more cost-effective. Looking at the discount window balance and BTFP combined, the balance of the Federal Reserve's two financing instruments was 164.8 billion US dollars on March 15, a sharp increase of 160.2 billion US dollars within the week of the Silicon Valley bank incident. As of April 12, the balance of the two financing instruments fell to $139.5 billion, falling for four consecutive weeks, reflecting continued improvements in the banking sector's liquidity situation.
Furthermore, FHLB advances are also an important way for banks to obtain liquidity. We use the debt issued by FHLB to indirectly observe how banks obtain liquidity from FHLB. As of the end of March, the balance of FHLB debt instruments was 1.48 trillion US dollars, an increase of 247.3 billion US dollars over the previous month.
Bank of America's deposits and loans have all rebounded week over week.We look at the weekly Bank of America balance sheet data disclosed by the Federal Reserve to determine the latest situation of large banks and small banks for the week ending April 5:
1) In terms of loans,The loan balances of large banks and small banks in the US increased by 13.1 billion US dollars and 3.1 billion US dollars respectively on a weekly basis, reversing the trend of declining loans after the Silicon Valley bank incident. Bank of America loan balances fell 56.2 billion US dollars and 40.8 billion US dollars respectively for two consecutive weeks. The loan contraction was mainly concentrated in small banks;
2) On the deposit side,The deposit balances of large banks and small banks in the United States increased by 21.1 billion US dollars and 23.6 billion US dollars respectively on a weekly basis. In the first week after the Silicon Valley bank incident, there was a risk avoidance phenomenon where deposits flowed out of small banks to large banks, and the latest data showed that deposits of large and small banks all had a net inflow;
3) In terms of loans,The loan balances of large banks and small banks in the US fell by 39.1 billion US dollars and 22.2 billion US dollars respectively from week to week. This also confirms the decline in the balance of the Fed's financing instruments described above, reflecting the liquidity crisis that led to a period of backward banks beginning to gradually repay their previous loans;
4) In terms of cash assets,The cash asset balances of major banks and small banks in the US increased 14.3 billion US dollars and fell 38.1 billion US dollars respectively from week to week. We believe that the decline in the cash assets of small banks was mainly used for loan investment and loan repayment.
Furthermore, we have observed a decline in a number of high-frequency indicators: The US financial pressure index declined significantly after its high on March 17. As of April 7, it had fallen below zero, reflecting that the pressure on the US financial market was becoming normal; the five-year CDS spreads of the four major US banks overall fell by about 20 bp from the high after the Silicon Valley Bank incident. The current level of interest spreads is not very high in history; the FRA-OIS spread also fell 30 bp from the March 13 high, reflecting the decline in risk premiums in the US banking sector.
We still need to pay attention to the subsequent contraction of bank balance sheets
The Silicon Valley bank incident may accelerate the downward trend in bank loan growth since 4Q22.There has been a marginal decline in the year-on-year growth rate of loans in the US banking sector in 4Q22, and the Silicon Valley bank incident has intensified the “credit crunch” to a certain extent.
In the loan structure, the year-on-year growth rate of industrial and commercial loans, consumer loans, and commercial real estate loans declined significantly. From March 8 to April 5, the balance of commercial loans and commercial real estate loans of the Bank of America fell by 31.7 billion US dollars and 28.6 billion US dollars respectively.
According to the Federal Reserve's SLOOS, the latest survey in January 2023 showed that bank credit standards were further tightened, while credit demand weakened significantly. In both data, changes in commercial real estate loans were higher than other types of loans, reflecting that banks tightened commercial real estate loan investment standards and related demand also weakened markedly.
At the end of 2022, commercial real estate loans from banks with total assets of less than 250 billion US dollars accounted for 80% of the banking industry as a whole, while the total assets of these banks accounted for only 45% of the total assets of the banking industry. In other words, small and medium-sized banks in the US invested 80% of the industry's commercial real estate loans with 45% of the total assets of the industry, and the concentration of exposure was high. Currently, the commercial real estate overdue rate is still low, but we need to be wary of the subsequent evolution of asset quality in a high interest rate environment. We believe that the credit risk of small to medium banks is greater than that of large banks in this round of interest rate hikes.
Annual accounts may continue to face outflow pressure, but the resilience of Bank of America deposits cannot be ignored.The big four banks said at the 1Q23 earnings conference that although deposit inflows occurred after the Silicon Valley bank incident occurred, the period was very short, and deposit balances may still decline year-on-year throughout the year.
Currently, the market's concerns about bank deposits in the US are mainlyThe Fed's overnight reverse repurchase interest rate is very attractive. Depositors may prefer to transfer bank deposits to money market funds and eventually invest in the Federal Reserve's overnight reverse repurchase instruments, causing liquidity to be removed from the banking system.
We believe that Bank of America's deposits have shown strong resilience in this cycle:
On the one hand, compared with historical interest rate hike cycles, the current deposit beta in the US banking sector is still low. As of the end of 2022, the deposit beta was only 0.24, which is significantly lower than the 0.43, 0.49, 0.50, and 0.29 of the previous four interest rate hike cycles. In particular, considering that this round of interest rate hikes is large, the current deposit beta and net interest spread levels are superior to market expectations. Banks still have a lot of room to compete with money market funds in the future by raising deposit interest rates. Therefore, bank deposits are currently mainly concerned about the impact on profits rather than liquidity risk;
On the other hand, at the 1Q23 earnings conference, JPM explained why banks are currently showing strong stickiness to public deposits. In order to obtain preferential loan interest rates from banks, small and medium-sized enterprises often choose to place their deposits in the same bank. We believe that after the liquidity crisis is resolved, customers are still motivated to deposit in small to medium banks. Deposit data from the past two weeks also confirms this.
2. The 1Q23 performance of the four major US banks exceeded market expectations
Four major US banks$JPMorgan (JPM.US)$,$Bank of America (BAC.US)$,$Wells Fargo & Co (WFC.US)$,$Citigroup (C.US)$The 1Q23 results were disclosed on April 14 and April 18, 2023. The net profit of the four major banks was better than market expectations, mainly due to a further increase in net interest income and an increase in proprietary trading revenue. The prices of JPM, BAC, WFC, and C shares rose 10%, 7%, 6% and 6% respectively from the 14th to the 18th.
Net interest income has exceeded expectations, and the outlook for the investment banking business for the whole year is still not optimistic.Net interest income from JPM, BAC, WFC, and C 1Q23 increased 49%, 25%, 45%, and 23%, respectively. Among them, JPM and C increased 3% and 1% month-on-month, while BAC and WFC decreased by 2% and 1%. Although net interest income has exceeded market expectations, we can observe that the quarter-on-quarter growth rate has slowed significantly and has even begun to decline. We think the main reason is that the current round of the Fed's interest rate hike is nearing its end, and the impact of deposit repricing is gradually showing.
The four major banks generally indicated that subsequent quarterly net interest income may fall below the 1Q23 level. The business revenue of JPM, BAC, WFC, and C 1Q23 investment banks decreased by 21%, 24%, 15%, and 25% year-on-year. There has been no significant improvement in the month-on-month data, and banks are still cautious about their capital market business prospects in 2023. However, due to strong FICC-related transactions this season, various banks performed well in their own transaction revenue.
The growth rate of non-interest costs declined from the high point of inflation, and the cost-to-revenue ratio declined.Non-interest costs for JPM, BAC, WFC, and C 1Q23 changed 5%, 6%, -1%, and 1%, respectively. The year-on-year growth rate of non-interest costs of the four major banks declined compared to the high point of inflation, so attention paid to performance meetings was significantly lower than in previous quarters. At the same time, due to the rapid revenue growth of the four major banks, cost revenue declined compared to 1Q23. Among them, JPM, BAC, WFC, and C declined by 3ppt, 2ppt, 15ppt, and 10ppt respectively.
The net write-off rates of the four major banks have rebounded from low levels, and expectations of a recession in the US have increased due to the Bank of Silicon Valley risk incident.JPM and BAC 1Q23 provisions declined slightly from month to month, while WFC and C 1Q23 provisions continued to increase month-on-month. On the one hand, various bank provision plans for this season came from the net write-off rate showing an upward trend from an all-time low, and on the other hand, from the increase in reserve reserves due to the continued weakening of US economic expectations. JPM said at the performance conference that the main reason for the increase in reserve reserves was that after the Silicon Valley Bank incident occurred, the weight of unfavorable situations in the company's expectations model increased. The WFC earnings conference indicated that the quality of its real estate exposure assets showed a weakening trend, and the retail loan overdue rate and net write-off rate also increased.
The year-on-year loan growth rate slowed further, and deposits grew negatively month-on-month.The average loans of JPM, BAC, WFC, and C 1Q23 increased 6%, 7%, 6%, and 1%, respectively. The average loans of the four banks were basically the same from month to month. The further decline in year-on-year growth reflects a weakening trend in credit demand. This is consistent with the performance of the balance sheet of Commercial Bank of America that we have been tracking recently. The average deposits of JPM, BAC, WFC, and C 1Q23 changed -8%, -7%, and 2%, respectively. The average deposits of the three banks other than C also declined slightly month-on-month. This reflects the contraction of liquidity and the intensification of money market fund competition in an environment of rising interest rates. The main reason C kept deposits relatively stable was its development and service relationships with public customers deepened. The powerful brands of the big four banks helped them obtain lower deposit betas and maintain relatively stable deposit balances.
3. Highlights of the 1Q23 performance meetings of the four major US banks
J.P. Morgan JPM
► Net interest income: Raising the 2023 net interest income guidance to 81 billion US dollars. The main reason for the increase is the current increase in expectations that the Federal Reserve will cut interest rates in the second half of the year, which may cause deposit costs to be lower than previous expectations. Furthermore, higher than expected credit card loan balances are also a major reason for the increase in net interest income guidelines. Deposit inflows caused by the Silicon Valley bank incident were not the main reason for the company's upward guidance. The outlook for the whole year still implies a repricing of deposits. The run rate of 1Q23 net interest income is 84 billion US dollars, the company's guidance for the whole year is 81 billion US dollars, and the medium-term NII is around 75 billion US dollars. The main reason is that there is still great uncertainty about the repricing of deposits.
► Deposits: Affected by the Silicon Valley bank incident, residents tend to choose to deposit at large banks. This quarter's deposit growth exceeded expectations, but the company still expects deposit balances to decline in 2023. Furthermore, due to the Silicon Valley bank incident, small banks will reprice deposit interest rates to make them more attractive, and JPM believes this will not affect its own deposit expectations. At the same time, long-term high interest rates are not good for banks; they may cause economic recession, stagflation, etc.
► Credit investment: JPM does not believe that there is currently a “credit crunch” (credit crunch), but admits that credit investment standards will be tightened in the future. Currently, the tightened loans are mainly concentrated in some real estate-related fields. Credit tightening may further increase the risk of a recession, but it's not a Credit Crunch right now. The company also did not have significant lending standards during the pandemic, so they will not overreact to tightening lending standards at this stage.
► Commercial real estate loans: JPM's main commercial real estate loans are distributed in the multi-family housing sector with limited supply. This is different from the higher-end, higher prices, unrestricted rent, and unrestricted supply. The overall risk of the company's commercial real estate loans is low. Among them, office buildings only account for 10% of the company's commercial real estate exposure and are concentrated in urban intensive markets. Currently, the US real estate market is in short supply, which is different from the serious oversupply in 2008.
► Regulation: The company believes that the Silicon Valley bank incident will not trigger a systematic regulatory reform and may increase scrutiny of some banks' TLAC, assets held until maturity, interest rate risk, etc.
► Asset quality: JPM further increased loan reserves, mainly because after the risk events in March, the weight of adverse situations increased. Currently, the weighted average unemployment rate peaks at 5.8%.
► ROE: The company believes that the target of 17% ROTCE crosses cycles. Even if the economy recedes slightly, the company still has confidence in the resilience of its performance, but as a bank, the company admits that a serious recession will have an adverse impact on profits.
Bank of America BAC
► Loans: The quarter-on-quarter growth rate of loans slowed, partly due to seasonal credit card payments after the 4Q22 holiday spending, while demand for public credit slowed in 1Q23. The company saw wealth management clients reduce leverage when interest rates rose, thereby cutting back on some expenses. Overall consumer consumption was weak in the first quarter. The company believes there are signs of an economic slowdown. It is expected that the economy will begin to experience a mild recession in the third quarter of 2023. Currently, consumers are more cautious about using cash, and the savings of low-income people are increasing.
► Deposits: The average deposit balance declined in the first quarter. As the Federal Reserve continued to tighten the money supply, the company remained stable at a high level of total deposits. The performance of wealth management accounts has declined relatively, and there is a trend of capital flowing from low-yield accounts to high-yield accounts. The company expects that this switching trend is close to its highest point and will slow down in the future. The company has stable customer deposits that far exceed loan requirements. The company expects deposit interest rates to be in line with market interest rates.
► Net interest income: Net interest income in the first quarter declined slightly compared to the fourth quarter due to both low deposit balances and interest-free conversion to interest-bearing deposits. Considering changes in expected deposits and a decrease in net interest income in the global market, the company expects net interest income to drop 2% in the second quarter. Based on the assumption that the Federal Reserve cuts interest rates in the second half of the year, the company expects net interest income for the whole year to increase, and indicates that the current market consistency forecast of 57 billion US dollars is relatively reasonable.
► Asset quality: The net write-off rate rose from an all-time low due to higher late overdue rates.
► Bond investment: BAC stopped increasing the allocation of holdings to maturity bonds after deposits peaked in mid-2021. Over the past six quarters, the company continued to reduce related exposure. Bonds generated a lot of unrealized profit and loss after interest rate hikes in 2022. Unrealized profit and loss peaked in 3Q22, and both 4Q22 and 1Q23 were on a downward trend.
Wells Fargo WFC
► Net interest income: This quarter's guidance for net interest income in 2023 remains unchanged. WFC believes that net interest income is affected by various uncertainties, including the absolute level of interest rates, deposit balances and repricing, loan demand, etc.
► Asset quality: Net write-offs of commercial loans increased slowly, mainly due to the weakening of loan asset quality and the increase in non-performing assets; consumer overdue rates and net write-offs also increased. The increase in non-performing loans for commercial real estate is mainly due to the weakening of the office market. Commercial real estate loans have not seen any particular pressure in the short term, but the company is expected to experience a period of risk release. The company said that it is now seeing signs of a weakening office market in cities such as Los Angeles and San Francisco. Rents in these regions are lower than the national average, or are being further impacted by long-term changes in office models.
► Deposits: How long high interest rates continue will affect this quarter's deposit beta. Considering the magnitude of the increase in the current interest rate level, the company believes that bank deposit betas have performed well in this cycle. Looking at customers, bank deposit betas for public customers are higher at this stage, and deposit betas for retail customers are lower.
► Business outlook: The company expects customer activity to remain relatively strong in 2023, and the overdue rate remains low. As for possible risks, such as commercial real estate loans, the company is shrinking its business, and at the same time, the company is actively withdrawing from some high-risk housing mortgage loan businesses.
► Capital Adequacy Ratio: WFC expects CET1 to remain stable. It does not take into account additional significant capital requirements and additional capital requirements due to a possible economic downturn, and believes that sufficient earnings can cover these needs even if future economic downturns occur. Currently, there is still a cautious and positive attitude towards shareholder buybacks.
► Silicon Valley Bank Incident: WFC believes that Silicon Valley Bank is different from a typical regional bank. It is a special bank with concentrated business and relies heavily on unsaved money, which has triggered a market squeeze.
Citigroup C
► Deposits: The cornerstone of C deposits is public deposits, which account for 60% of the company's total deposits. These deposits are highly sticky because most of them are in operating accounts and are integrated with the company's global business. The company said that 80% of its public deposits come from payments, liquidity management, and working capital solutions. The company said it will continue to observe the evolution of deposit betas, but deposit pricing should not be confused with deposit stickiness. The company sees a rise in deposit betas, especially in the treasury and trade solutions business. The company expects deposit betas to rise further in regions other than the US, but deposits will remain stable. After the Silicon Valley Bank incident until the end of March, C observed an inflow of deposits, mainly from medium-sized enterprise customers.
► Loans: The company expects the level of revolving credit to be maintained, but although consumption is still growing year over year, the growth rate has slowed, mainly in the travel and entertainment sector.
► Asset quality: 90% of the company's commercial real estate exposure is investment grade loans. As a result, although the macro and geopolitical environment remains highly uncertain, the company is very satisfied with asset quality, risk exposure, and provision levels.
► Liquidity risk: C's bond investments are mainly composed of highly liquid US Treasury bonds, institutional bonds, and other sovereign bonds, which are distributed evenly between what can be sold and held until maturity. The company maintains a bond term of less than 3 years, so it can benefit from higher interest rates.
► Future outlook: Despite continued economic uncertainty, the company's revenue and expenditure targets for the year remained the same. The company's current interest rate outlook is that interest rates may stabilize after the second quarter of 2023 and fall to around 4.5% by the end of the year.
Editor/Somer