R. Christopher Whalen
Jul 19, 20226 min
July 19, 2022 | Premium Service | We start this issue of The Institutional Risk Analyst by noting that the Fannie Mae 4.5% MBS for delivery in August is now above par, a measure of the impact of the bond market rally seen since the mid-June peak of 3.43% for the 10-year Treasury note. Today the 10-year T-note opened below 3% as the yield curve is now inverted from 2s through 10s.
Many analysts have still not caught up to the fact that the bond market has been in rally mode for the past month. “We think in the short term spreads have the potential to go wider and only when the risk factors start to abate would we expect spreads to turn tighter,” Bank America (BAC) analysts Jeana Curro and Chris Flanagan wrote in a July 15 client note. “Over the long term we would expect mortgages to outperform, but the timing is of course tricky.” Tricky indeed.
Meanwhile, BAC reported earnings this week and the results were decidedly mediocre, as we predicted in our earlier missive. First lien originations fell but home equity lines rose. Net interest income rose by $3.5 billion, but non-interest income fell by $2 billion in the first six months of 2022. A $1.5 billion tax bill and $500 million in provisions (both items were negative last year) and BAC’s net earnings were down $4 billion in the first six months of 2022. The summary from BAC’s earnings presentation are below.
BAC is currently trading at book value, which given the outlook for the company is probably about right. With 8 billion shares outstanding, BAC is one of the most widely held stocks on Wall Street and, as a result, has an army of apologists among Buy Side managers and the media. They've all made the same mistake and spend enormous time in justification.
Even though the bank continues to underperform its asset peers, CEO Brian Moynihan was praised in the financial media for a strong quarter. “Bank of America revenue tops expectations as lender benefits from higher interest rates,” CNBC declared on July 18th. But Moynihan continues to fall short in terms of his bank’s performance vs its peers.
The good news for BAC and other banks is that there is a discernable lift underway on the yield of bank balance sheets, with the return on earning assets (ROEA) for BAC up to 2.23% in Q2 from 1.89% in Q1 2022 and 1.79% a year ago. The difficulty is getting BAC and other underperformers such as Well Fargo (WFC) to tighten up their operating efficiency while they also build capital to meet higher requirements from the Fed.
“Management [at BAC] expects to build CET1 to 11.5% by the end of 2023 in response to increasing SCB & CSIB surcharges through a combination of organic capital generation and balance sheet optimization,” writes Jeffrey Harte at Piper Sandler. “While buyback activity is likely to be subdued in the near term, management sees an ability to continue repurchasing shares.”
BAC, for example, dropped its efficiency ratio down to 66% in Q2 2022 vs 68% in Q1 and almost 70% a year ago. But the bank is still not in the right neighborhood with JPMorgan (JPM) and U.S. Bancorp (USB) in the mid-60s in terms of efficiency. The chart below shows efficiency ratios for the top-five banks.
Source: FFIEC, EDGAR
Citigroup (C) was the big winner in Q2 2022 in terms of results, not so much in terms of the size of the increase in revenue and earnings but rather the stability of the results. The sub-65% efficiency ratio is also good news. The six percent increase in net income contrasted with the sharply lower results of some asset peers. One of the ways that CEO Jane Fraser can rebuild support among investors is to deliver results with less volatility and more consistency than BAC or WFC, which continues to be badly wounded from its regulatory problems.
WFC’s revenue fell $500 million in Q2 2022 and was down 11% in the first half of the year. The bank’s loyal following among managers is being tested by the deliberate downsizing of the bank, including a double digit runoff rate for residential mortgage exposures. With Tier 1 leverage sitting at 8%, we’d not be surprised to see further reductions in assets. The annualized ROEA for WFC was 2.7% at June 30, 2022, a good bit above BAC.
Most of the banks reporting last week saw slippage in residential mortgage lending and servicing. WFC saw third-party servicing assets fall below $700 billion as the bank continued to shrink. It was not so long ago that WFC's assets serviced for others was measured in the trillions of dollars.
“JPMorgan Chase, the second-largest depository home lender in the nation, originated $27.9 billion of first liens in the second quarter, a 7.6% sequential decline,” Inside Mortgage Finance reported. “Compared to the same quarter a year ago, loan production skidded an ugly 59.3%.”
During last week’s earnings call for JPMorgan Chase (JPM), CEO Jamie Dimon rebuked the Federal Reserve Board and other regulators for what the veteran operator described as “ridiculous” bank stress tests. He then went on to say that JPM and other banks will be forced to reduce 1-4 family mortgage exposures because of the Fed’s poorly conceived bank stress tests.
“We don’t agree with the stress test,” Dimon said. “It’s inconsistent. It’s not transparent. It’s too volatile. It’s basically capricious [and] arbitrary. We do 100 [stress tests] a week. This is one. And I need to drive capital up and down by 80 basis points? So, we’ll work on it. We haven’t made definitive decisions. But I’ve already mentioned about how we dramatically reduced [risk weighted assets] RWA this quarter. We may do that again next quarter.”
What is raising Jamie Dimon’s ire? Regulators recently determined that JPM could lose $44 billion in a highly stressed economic scenario, in large part on its $250 billion portfolio of 1-4 family mortgages. As a result, JPM is curtailing share repurchases until at least 2023. Read our analysis in National Mortgage News ("Faulty bank stress tests are hurting the mortgage market").
The other interesting notes so far in this earnings season was the rebound of Silvergate Financial (SI), the small bank located in Southern CA that was trading 12x book value in March of 2021, but then collapsed with the crypto bubble. SI has been up over 30% in the past month but is still down almost 50% YTD.
Another notable name from the world of crypto, Signature Bank (SBNY) had also rebounded strongly along with SI, but then got clobbered when strong earnings results were combined in a significant run off in crypto related deposits. SBNY is still down almost 50% and has given up all of its gains of the past month.
Finally, a name we highlighted recently, Ally Financial (ALLY), came in low on earnings and high on loan loss provisions, pushing the stock lower. The bank continues to originate auto paper and, indeed, beat analyst estimates by a wide margin. The good news is that the bank is “only” trading +270bp in five-year credit default swaps, but the ALLY 5 3/4s of 2025 and 4 3/4s of 2027 are trading +250bp in terms of the mid-market spread.
Bottom line on banks earnings: Higher credit provisions and taxes, and lower revenue seem to be the basic picture. Rising rates are starting to reprice bank assets, a process that promises to increase asset and equity returns in the future. But balancing this bright prospect will be continuing worries about credit after several years of great moderation by the FOMC. The fact of rising credit provisions at banks suggests that the great normalization is well underway.
Next in the Premium Service of The Institutional Risk Analyst, we’ll be looking at the Wall Street universal banks and advisors – GS, MS, SCHW, RJF. Our bank surveillance group is shown below. Please keep those questions and comments coming.
Source: Bloomberg (7/18/2022)
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