In my previous post, we discussed the Federal Reserve being under pressure to pause raising interest rates in March after the collapse of Silicon Valley Bank (SIVB) and Signature Bank (SBNY) had investors questioning the health of the banking sector. Despite the crisis, the Fed raised rates by 25 basis points to 4.75%-5% pushing borrowing costs to levels not seen since 2007. In doing so, The Fed demonstrated its renewed commitment to tame inflation. During the last FOMC meeting, several Fed officials’ hawkish comments pointed to another 25bps rake hike in May, furthermore, they accepted a potential recession this year.
Last week, the financial sector led the S&P 500 by gaining 2.8% as the big U.S. banks reported strong profits. Is the banking crisis over? Big banks are benefiting at the expense of the small banks as customers pulled their money placing it with institutions deemed too big to fail. If a big bank goes down, the whole economy would be at risk, so the Fed will most likely bail them out.
At least that is what many people think, so many small bank’s clients decided to move their money to banks such as JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs.
JPMorgan posted record Q1 net interest income of over $20 billion (a 49% incremental increase from the previous year). Wells Fargo posted a 45% increase, Citi 23%, and Bank of America at 25%. These banks are writing loans at over 6% with a much lower cost of capital as they pay little to zero interest to their customers who are looking for security instead of income. The small banks are being forced to offer over 4% interest to their customers to attract or keep them. As such, small banks will likely see smaller profit margins in the future. They will depend on new loans and be at a significant disadvantage to the big banks that will only grow larger and more powerful in the current environment.
JPMorgan Chase (JPM US Equity) 6-month Daily Chart
Data on Thursday the 20th showed banks increased emergency loans from the Federal Reserve for the first time in five weeks, signaling continued pressure on the banking system. Credit defaults are rising, and banks are preparing for the economy to get worse before it gets better. More and more Americans are behind on their car payments and are carrying credit card debt from month to month. Commercial property debt creates another risk for banks to prepare for as mortgages expiring in 2023 will test the health of banks. As office spaces in America continue to have record vacancy rates, companies who have adopted to a work from home environment will be tempted not to renew their leases. If commercial real estate falters, banks will potentially suffer significant losses.
Finally, investors and depositors remain uncertain about banks holding billions of unrealized losses in bond holdings. Although it is unlikely that depositors of banks will pull their money at the same time (what happened to SIVB), if banks are forced to mark to market “held to maturity assets” they will take massive losses.
Higher interest rates, big losses in low yielding bonds, and money fleeing to big banks creates a situation that can become very difficult to manage for bank executives and destabilizing to the broader economy.