First Take on FDIC Bank Data

June 1, 2023 | Premium Service | As we process the data from the FDIC for the first quarter of 2023, we have a couple of observations. We’ll be releasing our Q2 2023 IRA Bank Book industry outlook next week. For investors in banks and other forms of leveraged credit, a couple of obvious points are raised by the latest bank data release.

First, in terms of future earnings, the Q1 2023 numbers for the US banking industry included a big surge in non-interest income. The FDIC Quarterly Banking Profile states:

“The accounting treatment of banks’ acquisition of two failed banks and record-high trading revenue led the growth in noninterest income. Interest income increased $19.1 billion (7.9 percent) from fourth quarter 2022, but was offset by a $23.7 billion (38.2 percent) increase in interest expense. From the year-ago quarter, net operating revenue rose $47.0 billion (21.9 percent), as net interest income grew $37.7 billion (27.3 percent) and noninterest income expanded $9.3 billion (12.2 percent).”

Why is this important? Because neither above-normal trading revenues nor GAAP adjustments to income due to the acquisition of failed banks are going to repeat $19 billion worth of income for Q2 2023. The chart below illustrates the sharp drop in net interest income and the upward surge in non-interest income because of these two non-recurring events.

Source: FDIC

As we write these lines, Goldman Sachs (GS) is on the wire guiding down trading revenue 25% and preparing a further cull from the banker ranks. The message coming from GS and the other major trading houses is that deal volumes and new issuance is going to be sluggish across the board with the possible exception of jumbo mortgages.

This leads to our second point, which is that the gyrations seen in terms of non-interest income are likely going to continue in Q2 2023 and beyond as banks focus on reducing bond positions to 2018 levels. It is remarkable to us that Morgan Stanley’s (MS) bond analysts went to overweight MBS yesterday. MBS spreads over Treasury paper are at decade wide levels, yet selling pressure from banks, which still own $2 trillion in MBS, will continue.

Source: FDIC

Banks have reduced available for sale securities by about a third since the peak of $4 trillion in Q4 2021. After that time, the industry saw bond valuations slide 20% as the FOMC raised interest rates 500bp. The mark on AFS and HTM securities in Q3 2022 was negative $800 billion or so. The reduction in the size of bank securities holdings now pushes the negative market down to a more managable $500 billion. This is a very welcome development and also entirely necessary.

The good news is that aggressive sales of securities have pushed down the ugliness of mark-to-market disclosure on legacy, COVID era exposures. Loss on securities sales in Q1 2023 were only $2.1 billion. We look for AFS securities owned by banks to fall another $500 billion back to 2018 levels over the next year.

The bad news is that banks face a difficult couple of quarters ahead when rising funding costs could push some banks into a loss. Loans and securities currently held in portfolio could end up being reclassified and sold with the attendant ugly disclosure.

We did the math with Bank of America (BAC) in our last comment. Below let’s take the numbers for Peer Group 1 for year-end 2022 and then extrapolate based upon the Q1 2023 actuals. If we assume that asset returns will continue to rise low double digits, but that bank funding costs will rise 3-5x asset returns, then the US banking industry is barely making money in Q2 2023. The Q1 2023 numbers for non-interest income skew up to $80 billion, but then return to the $65 billion average in Q2 2023.

Source: FFIEC, WGA LLC

FDIC Chairman Martin Gruenberg set the stage for Q2 2023:

"The banking industry has proven to be resilient. In the first quarter, net income was flat but still high by historical measures, asset quality metrics remained favorable, and the industry remains well capitalized. However, the industry’s quarterly results do not yet fully reflect the stress that began in early March. The banking industry also faces significant downside risks from the effects of inflation, rising market interest rates, slower economic growth, and geopolitical uncertainty. These risks have the potential to weaken credit quality and profitability and could result in further tightening of underwriting, slower loan growth, and higher provision expenses."

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