USB Management on Fiscal Cliff

US Bank management thoughts on consumer credit impact of the fiscal cliff, from 3Q Earnings call:

P. W. Parker - Chief Credit Officer and Executive Vice President

Well, if the worst case happened on the fiscal cliff, I think it's fair to say we'd probably reenter a recession. And that would be then you'd see unemployment go up, and that would have an impact on consumer portfolio. I'm hopeful that they come to some kind of resolution, and I think the fiscal cliff was designed in such a way that it's so severe. I think it's unlikely that there won't be some political solution that cuts the middle ground and mitigates that risk.

Q3 Bank Earnings Preview

JPM will kick off earnings season for financials tomorrow, and the whispers seem to be that the quarter is going to be pretty good.  Hopefully JPM will show signs that the banking system is continuing to heal and that profitability is returning.  Whereas a couple of years ago investors would have had a laser like focus on capital and asset quality metrics, this quarter the metrics that I'll be paying close attention to are (among others): Return on Equity, Loan Growth and NIM.  Below are charts of how these have trended for the banking system over the last decade.

While asset quality has gotten a lot better for the aggregate portfolios and charge offs have slowed to pre-recession levels, banks are still holding a lot of non-accrual assets in their residential books.  It will be important to see if the system is taking the opportunity provided by improving housing prices to finally clean their books completely.  This will have major implications for future lending.

Regions Financial Loan Line Utilization

More from the Barclays Financial Services conference...a slide from Regions Financial, a southern regional bank with +$100B in assets which had a lot of trouble with credit quality during the crisis.  The slide below shows loan line utilization improving.  It's a big step forward for this bank just to not have to focus on credit quality, the fact that they are focusing on loan growth shows how far the banking sector has come since '09.

More Confirmation that the Housing Market May be Turning

In the Federal Reserve Senior Loan Officer Survey released yesterday, there was a good sign for the housing market in that more banks are reporting increasing demand for mortgage loans.  The bad news is that while the demand is picking up, banks are still not loosening credit standards much, and actually reported tighter standards last quarter.

Did the Repeal of Glass Steagall Cause the Financial Crisis?

Sandy Weill, former CEO of Citigroup caused a stir today by commenting that Glass Steagall should be reinstated.  Since he is the person who pioneered the integrated banking model, the comments are shocking.  The comments are puzzling too because even if one thinks that separating commercial and investment banks would create more stability in the long term, it's not entirely clear that the financial crisis stemmed directly from the integration.

Empirically, not a single integrated bank failed in 2008/2009.  Lehman and Bear were not commercial banks, and Indymac and WaMu weren't investment banks.  AIG, Fannie and Freddie were not banks of any sort.  In fact, Goldman and Morgan Stanley (along with some insurance companies) were saved by converting to bank holding companies so that they could access liquidity at the Federal Reserve.

The argument for a separation of commercial and investment banking activities perhaps stems from the belief that depositors ("main street") need to be protected from the volatility of securities markets. However in today's economy, only a tiny portion of household savings is held as deposits anyways, so the savings of main street are far from insulated from a collapse of an investment bank (even if it were separated from the commercial banking system).

Below is a list of bank failures in 2008.  Note that Lehman, Bear, AIG, Fannie and Freddie are not on the list.  In all, 447 banks have failed between 2008-2012.  The vast majority were community banks that were in "less risky" lending businesses.  The fact is that banking is risky business in any form.

2008 Bank Failures

How Does Housing Compare to the Tech Cycle?

Even though Bank of America is trading lower, today's quarterly release capped off what was a surprisingly good quarter for major US Banks.  In general, loans and deposits both showed growth, capital levels are extremely high and credit quality is significantly improved from where it was during the crisis.  Similarly, the housing sector has had some healthy reports as well recently (see previous post).

Seeing as how housing and banking were at the epicenter of the previous crisis, what does the fact that the two sectors are recovering say about where we are in the current economic cycle?  To try to help discern how this cycle compares to previous cycles, below is a chart comparing the performance of housing (ITB) and Financials (XLF) in this cycle to Technology (XLK) in the last one.  The chart shows relative performance of ITB, XLF and XLK compared to the S&P 500.  ITB and XLF are shown from 2006 and 2012 and XLK is shown between 2000 and 2007.

After the sharp collapse of technology stocks relative to the S&P from 2000-2002, XLK languished on a relative basis for the next four years before finally starting to outperform in 2006.  Similarly, both XLF and ITB showed steep drops and have continued to be losers since.  Now, years later, they may finally be starting to show signs of a turn.  XLK continued to steadily outperform the S&P 500 through 2012.  However, by the time XLK turned in 2006, the general economy only had one year left before it began to contract.

How Long Will It Be Until XLF Makes a New All Time High?

XLV may be making new all time highs, but its cousin, XLF is far from the point where it could make new highs of its own.  Thanks to the heavy dilution that the financial sector incurred during the financial crisis, the companies that make up the XLF were among the few large companies that sustained permanent losses of capital since 2008.  XLF made an all time high of $38.15 in 2007, but today sells for just $14.76.  

Given the extreme destruction of capital it will be a long time before the financial sector makes back its losses per share, but eventually it should get there.  XLF had a book value of $15.07 as of the end of 2011.  If the ETF trades in line with book value and grows book value per share by 8% per year, XLF will reach a new peak around 12 years from today, 2024.

WFC 2Q12 Conference Call Highlights

Quotes from 2Q12 WFC Earnings Call

• organic growth in both commercial and consumer portfolios.

• average core deposits up $10.1 billion from the first quarter, up $73.2 billion or 9% from a year ago. 

• net interest margin was unchanged at 3.91%

• established an efficiency ratio target of 55% to 59%

• charge-offs were...1.15% of average loans, down...$3.2 billion or 59% [from 4Q09 peak].

• Nonperforming assets were down $1.8 billion from the first quarter, down 11% from a year ago. NPAs were 3.21% of total loans in the second quarter, the lowest level since 2009.

• Our estimated Tier 1 common equity ratio under the latest Basel III...7.78% for the second quarter

• Return on assets was 1.41%, the highest in 16 quarters and within our target range of 1.3% to 1.6% that we provided on Investor Day. Our ROE grew to 12.86%, also within our target range of 12% to 15%

• I think the market continues to provide opportunities for firms that have the liquidity and the capital to [make acquisitions]. Whether or not we'll be successful, I certainly can't promise you because we turn down more than we pursue.

• We're not taking any significant duration risk or any significant credit risk [in the securities portfolio]. This is still a very high-quality portfolio and the duration is relatively short.

• Random quote from Stumpf that typifies WFC culture: But, Mike, we will not stretch for something. If -- I mean, that we -- it's just not in our culture to do that. So if we happen to have something that goes down one quarter, that's life.

Deposit Growth at US Banks

Citigroup reported strong earnings this morning as did JP Morgan and Wells Fargo last week.  All three banks also reported strong deposit growth as well.  Systemically, despite low interest rates, US banks have been growing deposits at an above average rate.  Y/Y, savings deposits grew by 11.5% as of the week of July 2.  On average, since 1985, savings deposits have grown by 8.4% Y/Y.  The higher than average growth in deposits since '09 suggests that Americans are more comfortable saving via deposits rather than capital markets.