Logan Riffs on SOMA; XYZ and SYF Say No Recession Yet

February 26, 2025 | 高端服务 | As we cautiously approach the end of the month of February, the financials continue to retreat, but without great bearish conviction. As with the market for Treasury debt, yields want to move lower and therefore prices higher, but the pace of changes coming from the Trump Administration in Washington is keeping markets unsettled. Jim  Lucier at Capital Alpha Partners sets the stage:

“President Trump's ‘flood the zone’ strategy is deliberate. It is part of a carefully calculated shock-and-awe effect, and not least of this shock-and-awe effect is what President Trump is trying to do to bring the federal bureaucracy under control – not just mass firings, layoffs, buyouts, or return-to-office policy, but a number of important personnel changes that he had hoped to implement in his first term, but which he wasn't able to.”

Meanwhile, no less an authority than FRB Dallas President Lori Logan informs us that she prefers to see the Federal Reserve Board buy Treasury bills as and when the Fed decides to resume net-purchases of Treasury debt for the system open market account (SOMA). This is the way it is supposed to be, unless the FOMC suddenly decides to buy residential mortgage-backed securities (MBS).

Logan’s views are hardly new and simply restate the Fed’s traditional policy of mirroring the issuance of different maturities of Treasury debt in SOMA. Yet clearly, Logan's regular yowling about the balance sheet suggests there are growing perturbations in the world of monetary mechanics.  When the Fed bought all of those low-coupon mortgage securities in 2020-2022, the duration was in low single digits, but today those MBS have durations in excess of 15 years with commensurately lower prices.

Despite the reticence of Logan to provide any details as to when the modest shrinkage of the SOMA portfolio will end, there is already evidence that the Fed is about to pivot toward more aggressive ease. In this Premium Service edition of The Institutional Risk Analyst, we describe the next leg in FOMC policy and update readers on Q4 2024 financials for Block (XYZ) and Synchrony Financial (SYF). We’ll be publishing our IRA Bank Book Quarterly next week. 

While it is interesting to see Lori Logan talking about the Fed balance sheet as the Trump Administration works to pass its fiscal package through Congress, the fact is that the Fed really does not know how much more to reduce the SOMA portfolio.  Like much of monetary policy, the Fed members guess. But getting the Fed's balance sheet wrong has real world consequences.

“The Fed’s plan is to continue QT until reserve balances are about $300 billion above the amount banks need, but it doesn’t know the amount banks need,” writes Bill Nelson of Bank Policy Institute. “As noted in the minutes, New York Fed staff expressed concern that the debt limit swing could leave reserves below the amount the Fed discovers is correct.  In reaction, ‘various’ FOMC participants stated that it might be appropriate to pause or slow balance sheet runoff until the resolution of the debacle.”

The task of the FOMC is made more difficult because of the volatility of economic indicators. The fact that consumer confidence fell in February reflects a number of short- and long-term factors, not the least of which is a wave of federal layoffs c/o Donald Trump. Private employers have been cutting headcount at a brisk clip for months.

The Conference Board summed it up: “In February, consumer confidence registered the largest monthly decline since August 2021,” said Stephanie Guichard, Senior Economist, Global Indicators at The Conference Board. “This is the third consecutive month on month decline, bringing the Index to the bottom of the range that has prevailed since 2022.”

Falling consumer confidence coincides with moderately rising credit defaults across the financial sector, but nobody is calling a recession in sight. “Past-due and nonaccrual (PDNA) loans, or loans 30 or more days past due or in nonaccrual status,” reports the FDIC, “increased 7 basis points from the prior quarter to 1.60 percent of total loans. The industry’s PDNA ratio remained below the pre-pandemic average of 1.94 percent.” 

Net, net, the economy is still not showing signs of a recession. Credit provisions expense for the US banking industry actually fell in Q4, reflecting some of the mixed results that we have reported already. Non-owner occupied commercial real estate remains the biggest credit pain point for banks. Yet the largest risk to financials and markets may be the situation at the Federal Reserve Board as they try to again guess how much is too much when it comes to shrinking the balance sheet.

Synchrony Financial

SYF provided another good quarter in terms of earnings and credit, with losses up slightly but loan loss reserves down YOY and sequentially. The bank’s results included 3% growth in topline earnings and a similar increase in funding costs. As the chart below suggests, over the past five years SFY has been a better investment than XYZ, this despite the early stellar performance of the latter. As we discuss below, XYZ is the latest name to get punished for missing Street expectations for earnings and growth.

Source: YahooFinance (2/25/2025)

SYF earnings were helped by lower credit provision expense driven by reserve release of $100 million vs. a reserve build of $402 million in the prior year, which was partially offset by higher net charge-offs.  The charts below from SYF Q4 2024 results show that loss rates are steadily building from the COVID-era lows, but still relatively pedestrian by historical standards. 

Synchrony Financial Q4 2025

Looking at 30-day and 90-day delinquency, since 2023 trends at SYF have actually been falling, but realized losses are climbing as the markets normalize post-COVID. This does not exactly fit into the recession-soon narrative. We watch SYF because the relatively broad, high loss rate portfolio that is purchased from a number of partners and therefore gives us a unique perspective on the larger trends of credit nationally. Of note, SFY is guiding investors to single-digit revenue growth and net loss rates at or below 2024 levels. 

With a 32% efficiency ratio, this bank’s earnings capacity allows it to absorb relatively high credit loss rates. The 21% yield on loan receivables and total funding cost of 4.5% on its 80% of assets in deposits provides ample profit support for credit – for now. In a higher loss rate environment, this arithmetic can change quickly. The bank buys a significant percentage of assets to replace the equally large number of loans that prepay or default during the course of the year. In Q4 2024, for example, purchase volume was $48 billion or half of the year-end loan book.

The SFY reserve release in Q4 comes after accommodating the purchase of the point of sale financing business, including $2.2 billion of loan receivables, from Ally Financial (ALLY) in March 2023. The acquired ALLY portfolio included relationships with nearly 2,500 merchant locations and more than 450,000 active borrowers in home improvement services and healthcare. The reserve build of $180 million was easily done because the bank’s strong income allows it to readily assimilate large asset purchases. 

Bottom line is that SYF is not yet showing any signs of financial stress, but loss rates continue to normalize somewhere around 6% net charge-offs. The bank is projecting 2.2% GDP growth and 4.1% unemployment for 2025, hardly a negative forecast, but not a roaring economy either.  Like 2023 and 2024, the year 2025 may end up being relatively stable for financials, yet investors remain worried about stealth externalities.

Block Inc.

XYZ saw two significant achievements in 2024: improved profitability and relatively stable results. The firm reported $1.3 billion in net profit, then saw results more than double because of a $1.5 billion tax credit and a $500 million revaluation of the Bitcoin portfolio for 2024.  All of that was inadequate to meet the expectations of the Street, however, and the stock was punished badly as a result. We think the selling in XYZ has as much to do with the earnings miss as with the poor trend for Bitcoin this quarter.

Source: YahooFinance (2/25/2025)

"Block reported earnings of 71 cents per share, falling short of the average analyst estimate of 87 cents, according to LSEG, notes MacKenzie Sigalos at CNBC. "Revenue of $6.03 billion also missed expectations of $6.29 billion. The company posted $2.31 billion in gross profit for the quarter, a 14% increase year over year, but slightly below consensus estimates."

Bitcoin revenue is still the largest single line item for XYZ, but the cost of Bitcoin dealing is 97% of the revenue, so the gross revenue line is the best metric for the business. After Bitcoin, subscription based services is the next largest item and also the most profitable. Looking at market prices for Bitcoin YTD, XYZ will likely be taking a mark-to-market loss for Q1 2025. 

In product terms, the cash app is the leading product and clearly the focus for the future. Like many of its peers, XYZ is in a battle for market share and customer engagement vs the likes of PayPal (PYPL), SoFi Technology (SOF) and the Fiserve (FI) unit Clover. The focus of XYZ is households up to $150k annual income, but they will take eyeballs where they can find and acquire customers. Paycheck deposit accounts at XYZ have grown strongly and the platform saw almost $300 billion in total account inflows in 2024. 

All of this said, XYZ has performed poorly in the equity markets for several years, part of the maturation process that seems to occur will all emerging nonbank financials. Once XYZ became about profitability instead of sheer growth of the early years, the fascination for markets has seemingly waned. Added to the investor fatigue factor, however, is the fact of slowing growth rates and the mounting ranks of competitors for the underserved consumer.

Also, we continue to wonder why the firm still dabbles in bitcoin trading given the volatility it introduces to the balance sheet and the distraction it provides from the rest of the business. Would any prospective acquirer want to take the risk of buying XYZ with its large principal position in bitcoin? Maybe that is the point. At some stage, however, XYZ management is going to come under pressure to sell if the performance of the stock does not improve.

The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.