R. Christopher Whalen
Mar 1, 20213 min
In this issue of The Institutional Risk Analyst, we present five key relationships that describe the progress of US depository institutions since March of last year. The good news is that the dip in earnings and asset quality is far less than the 2008 crisis, suggesting that the economic pain affecting millions of Americans due to COVID is not hitting US banks. The bad news is that the Cares Act and state debt payment moratoria are concealing the true credit cost of COVID – for now. And ugly is the state of bank asset returns as we approach year one of QE 5.
Source: FDIC
The chart above shows asset and equity returns for all US banks through December 31st of 2020. Note in particular that while equity returns in the form of earnings have rebounded in the short-term due to sharply lower credit provisions, asset returns have not. Indeed, although the yield curve has steepened in the past month, this due to the glaring lack of credibility with the bond market of the Biden Administration, the investment returns available to US banks remain muted and are declining.
Banking industry income rose in Q4 2020 due to declining credit costs, which dropped to just $3.5 billion for the entire industry in Q4 compared with $14.4 billion in Q3 and $61 billion in Q2 2020. Likewise funding costs for US banks fell to 2015 levels of just $11 billion for almost $21 trillion in bank assets. As the chart below illustrates, bank income has recovered but the Fed has not yet allowed dividends from insured banks to their parent holding companies to resume pre-crisis levels of payout.
Source: FDIC
The pivotal role of provisions in the bank earnings outlook is even more important than usual because of the lack of visibility on future bank credit losses. The loan payment moratoria imposed by Congress via the Cares Act and also by the states via various types of consumer and business moratoria make it difficult to assess forward loan loss exposures. At the moment, regulators are allowing banks to reduce provisions and even return some reserves into income, as shown in the chart below. Down the road, this positive credit trend may well be reversed.
Source: FDIC
The distortions in loan credit performance caused by the Cares Act and state loan moratoria are shown in the chart of the $11 trillion in total bank loans below. Loan delinquency is rising, but loan losses in the form of charge-offs are falling. Since state and federal regulators are essentially giving banks a pass on recognizing loan losses, loan loss provisions are also falling as shown in the previous chart. How long with this divergence between loan delinquency and actual realized loan losses persist? Until Congress and federal regulators decide to reinstate GAAP accounting.
Source: FDIC
Aside from the now political question of the timing of recognizing actual credit losses, the larger issue facing US banks is the relentless compression of yields on loans and securities. Via QE 5, the Fed is slowly killing the ability of banks and other investors to generate returns on fixed income assets.
From a recent high of 85bp in 2019, the return on earning assets for all US banks has fallen to just 70bp at the end of 2020. While the FOMC may think that tapering purchases of securities is a monetary policy question, the fate of US banks depends upon this calculous as well.
Source: WGA LLC