buy bank stocks on the dip

[chasesfish]

Reviving our thread here....

After the Fed press conference today, the 5yr Treasury is at 4.57%.

That exceeds the *pain* threshold on many commercial real estate deals.  If it closes above this level at quarter end, expect the bond mark discussion for the banks to resume as they report earnings in mid October.   You'll likely see problem loan reserves increase and expenses start to increase, I expect they'll start appraising properties early of the maturity date and increasing reserves on any 2024 maturities.

For those who believe banks will just "extend and pretend", it's antidotal evidence but a deal I looked at earlier this year gave the borrower six months to move his stuff.  He didn't and the bank filed foreclosure proceedings in advance of the maturity date.   Ameris is looking at a $500,000 style loss on a $3,800,000 loan.

First Horizon, which I talked about earlier this year, is taking a $75mil chargeoff against reserves for a large corporate credit.   The other side of mainly being a variable rate lender is if you are leading a large corporate syndication and the company hits a bump, it's harder for them to dig out of 8.5% rates than it is 4% rates. 

There's nothing to do yet, just hang on to some cash and be prepared to buy prefs if/when we start seeing some carnage.   This isn't 2008, but we could very well experience 2, 3, or 4 waves of bad news that gives you an opportunity to buy credit or preferreds on the secondary market.

Earnings on the other side of this will be robust for banks with 100yr old deposit portfolios and rural branches.  That's still lazy money that doesn't have to be priced all the way to market. 

[ChpBstrd]

@chasesfish Ha! I actually ran to this thread to ask your thoughts when I noticed the 5y treasury exceeded 4.5%.

I think you're right that a few-day peak followed by rates falling might affect the discussion around bank assets differently than a sustained >4.5% five year rate. Banks should be putting together their financial reports within the next few weeks, and making any last-minute decisions to massage their earnings.

A wide variety of such decisions could be summarized as taking one's lumps now or postponing until later. I'd be interested to know your thoughts. If execs are thinking about taking lumps early rather than later, it could be a play on bank earnings coming in under expectations.

IMO, the anecdotes you shared suggest executives are in the mood to clear out bad debts ASAP so that they don't get in a position of having too much capital tied up in an increasing pile of delinquent loans as liquidity dries up and ratios deteriorate. I.e. if you are pessimistic about the future and/or in an asset allocation that you regret, it seems to make sense to pull ahead losses in order to spread the pain across more time to be absorbed by more earnings. That way, when the SHTF you've got a relatively cleaner loan book.

Bank loans to consumers and businesses have both fallen this year, but only by a little. I think this is consistent with a bank strategy to replace low-interest loans with high-interest loans and with aggressive recognition of bad debts. But maybe there are other interpretations.

[chasesfish]

Banks need to be prepared for higher rates for longer.  The Fed has done exactly what they have said they will do since March of 2022.

"Lumps now or postponing" is more about realizing some securities losses now, taking the hit to GAAP, to reinvest the money in higher yielding assets, either market rate loans or new securities.  There's a balance between managing the ongoing NIM and not realizing a loss that will correct themselves.

Just "hoping rates go down" isn't an affective business strategy.

The most challenging part for many of these executives will be right sizing (shrinking) the bank.  There's no reason to pay up to market rate for the last CD dollar or FHLB advances while also carrying a low yielding securities book.   Instead you shrink the bank, get back to doing what banks do (loaning idle community deposits back into the community), and stop playing the size game by paying top dollar for the last incremental liability (deposit) while putting it in the lowest yielding marginal asset (loan).   Shrinking the bank probably requires taking securities losses, thereby admitting it was poor management.  The worst part is many of these banks are using the exact same people to manage their securities that got them into this mess (same treasurer, same outside investment firm).

The banks that will perform well this cycle are the ones who did exactly what a bank should do:  Take idle deposits in the community and loan them out to credit worthy consumers and businesses in that same community.   There are good lending institutions still carrying a stock trading at 1.25x to 1.5x book value that will be scooping up deposit heavy banks that are crummy lenders for prices below their book value. 

[ChpBstrd]

5-year treasury has hit 4.62%.

[chasesfish]

5-year treasury has hit 4.62%.

Now banks are going to have painful bond marks this quarter.  Maybe we can get some doomer stories that trigger a sale on some decent companies.

[ChpBstrd]

Fast-rising long-term rates have led to a rout in shares of BAC, USB, C, and RF, among others. Some of these are at or below where they were in May, before the Bank Term Funding Program put everyone at ease. For posterity, blue-chip preferred stock yields are:

BAC-B     6.2%
TFC-R     6.24%
WFC-Z    6.32%
HBANP    6.57%
CFG-E     6.63%
FHN-D     6.64%
C-K         6.81%
RF-B        6.91%
NYCB-U   7.56%
OZKAP     7.63%
BOH-A     7.68%
ZION-P    7.9%

Probably some investors have concluded rising long-term rates will definitely lead to a CRE bust, while at the same time dragging down the market value of all the long-term bonds and mortgages these banks bought this year and last.

The 125bp increase in the 5-year treasury since May, for example, is the same size as the rise between late March 2022 and late March 2023! Banks have sustained fresh damage, even the ones that were responsibly reinvesting capital at higher yields earlier this year, and it's probably serious damage. We might see a repeat of March-April later this year or in early 2024 and that would probably be "the dip" we've been waiting for.

The extent of investor nervousness can be seen in the chart below, which is the average 30y mortgage rate minus the 10y treasury. The spread between these assets recently exceeded the last highs set in December 2008! The most recent time this spread was as high as it was last month was 1986, amid the S&L crisis.


Yet it's all expectations so far, as the delinquency rates on CRE and mortgages remain low.

[chasesfish]

We're in for a slog of a 2024 in bank stocks.  The question becomes when will the common shares bottom in advance of this earnings slog?

Price paid is so important and by that I mean price relative to tangible book value.  All the bond banks are going to take larger marks this quarter to net worth and we're going to see loan loss reserve builds eat into earnings over the next 4-6 quarters, so tangible book value won't be grown internally.   I still think there will be buying opportunities in the banks that are good banks:

I'll be interested to see what pressure the regulators put on the largest bond banks out there ($ASB $BOH $SCHW $FFIN)   These banks all have....what I'll call off balance sheet equity.  Things about their business that are desirable to an acquirer.  Do regulators force a marriage?  Do they force a capital raise?  Are they forced to suspend dividends?  What is the resolution for bond marks taking them into severely undercapitalized range and the accompanying low yields squeezing earnings?    The bond banks are uninvestable with the unknown risks from regulators, but once that's know they'll get attractive again because they own credit grade securities with an embedded 30-50% gain in the bank's net worth over time.

I still don't expect a ton of failures due to credit risk (yet).   There's still margins and earnings power to build loss reserves.   

[MustacheAndaHalf]

@chasesfish - Maybe you can help settle something.  Back in March, the Fed backstopped Silicon Valley Bank (SVB), buying up its bonds to keep it solvent.  So bonds moved out of SVB, and cash moved into SVB.  Here's my question: where did that cash go?  where is that money now?

I had a theory that Fed actions which inject cash into the market act like Quantitative Easing, and loosen financial conditions.  If that's wrong, I'd like to find out.  If the cash stayed inside SVB or the banking system, and didn't get spent by businesses and consumers, then I'd have to say the overall effect was not QE.

[chasesfish]

@chasesfish - Back in March, the Fed backstopped Silicon Valley Bank (SVB), buying up its bonds to keep it solvent.  So bonds moved out of SVB, and cash moved into SVB.  Here's my question: where did that cash go?  where is that money now?

I guess I don't understand the premise of the question.

SVB was failed.   All assets went to the FDIC at current market value.   That was a negative value compared to what was carried on the books.   The deposits also equated to some goodwill assets.

The FDIC sold all the bonds, auctioned the loans, and auctioned the deposits.   Cash went to the FDIC from the acquiring banks / bond buyers.  The difference was made up from the FDIC insurance fund, which gets replenished by assessments against community banks.

[chasesfish]

The second comment:   That is different than the BTFP (buy the f-ing paper) facility setup to provide liquidity at 100% of face value against treasuries that are marked.  The Federal Reserve holds these treasuries as collateral and is made whole if that bank fails, only losing the opportunity cost of interest.  That facility *is* short term QE.   You can see the three month bump is created by this.  The March 15th to March 22nd increase in assets prevented the total assets from falling below that number again until mid-June.

https://fred.stlouisfed.org/series/WALCL

[MustacheAndaHalf]

The second comment:   That is different than the BTFP (buy the f-ing paper) facility setup to provide liquidity at 100% of face value against treasuries that are marked.  The Federal Reserve holds these treasuries as collateral and is made whole if that bank fails, only losing the opportunity cost of interest.  That facility *is* short term QE.   You can see the three month bump is created by this.  The March 15th to March 22nd increase in assets prevented the total assets from falling below that number again until mid-June.

https://fred.stlouisfed.org/series/WALCL

Thanks for the explanation of the BTFP facility, appreciate it.  I conflated this "BTFP facility" with making SVB customers whole.  I didn't realize the jump in the Fed's balance sheet (as shown in that Fred graph) was caused solely by BTFP.  Thanks for clarifying that.

My view is that QT has been mixed with QE, diluting the impact.  The Fed's mistaken belief in "transitory" resulted in a flip from QE to QT with only a few weeks apart (last year).  A potential crisis was averted by BTFP, but that QE undid months of QT.  The Fed says its policies act on "long and variable lags", but I think a mix of QE & QT extends those lags even further.

[ChpBstrd]

The second comment:   That is different than the BTFP (buy the f-ing paper) facility setup to provide liquidity at 100% of face value against treasuries that are marked.  The Federal Reserve holds these treasuries as collateral and is made whole if that bank fails, only losing the opportunity cost of interest.  That facility *is* short term QE.   You can see the three month bump is created by this.  The March 15th to March 22nd increase in assets prevented the total assets from falling below that number again until mid-June.

https://fred.stlouisfed.org/series/WALCL

Thanks for the explanation of the BTFP facility, appreciate it.  I conflated this "BTFP facility" with making SVB customers whole.  I didn't realize the jump in the Fed's balance sheet (as shown in that Fred graph) was caused solely by BTFP.  Thanks for clarifying that.

My view is that QT has been mixed with QE, diluting the impact.  The Fed's mistaken belief in "transitory" resulted in a flip from QE to QT with only a few weeks apart (last year).  A potential crisis was averted by BTFP, but that QE undid months of QT.  The Fed says its policies act on "long and variable lags", but I think a mix of QE & QT extends those lags even further.

I agree the BTFP is essentially QE (minus the 5.5%-6% interest paid on these loans), and that the BTFP has essentially offset some QT. However, I'll add my opinion that it makes a difference where the money is going.

QT is draining money supply from the healthiest and most liquid part of the financial system - the treasury market. Meanwhile, the BTFP is adding money supply to the sickliest and most likely to lock up part of the financial system - community banks. It is redistribution of cash from where it is not scarce to where it is desperately needed.

As of August 31, the BTFP had just over $121B in loans outstanding. This is steadily up from $83B on April 30. Thus the ~$38B growth in the BTFP over four months has been dwarfed by the $95B per month QT.

Interestingly, the BTFP has no monetary upper limit that I could find, so it is conceivable that BTFP growth could exceed QT in a crisis if banks had no other options, causing net QE/QT to equal zero for a month or two. The BTFP is authorized to make one-year loans until March 2024. I assume the program will be extended another year, but a lot of debt will need to be rolled over in early 2024, as the growth of the program was front-loaded.

There also may be a difference - in terms of money supply and inflation - between helicopter money which constitutes much of the growth in M1 and is "owned" by the public and BTFP loans to banks, which are a layer of debt secured by collateral assets. This is like the difference between having an extra $20 in your wallet because you got a gift versus having an extra $20 in your wallet because you took out a loan. The gift is something to be spent, but the loan is just to get you by until you can pay it off.

Bank collapses are disinflationary, so keeping banks afloat with BTFP loans causes a higher rate of inflation than would otherwise occur. However, I don't think liquidity added to the system to keep banks afloat a little longer is in the same league as stimulus checks. I could be wrong about that, due to the multiplier effects of banking, but I think most of these funds are sitting in stagnant accounts to keep ratios above a certain level and to prevent runs. The funds aren't chasing goods and services - they're being hoarded and plugging holes.

[MustacheAndaHalf]

This graph shows BTFP reaching $100 billion total:
https://fred.stlouisfed.org/series/H41RESPPALDKNWW

But from March 8 to March 22, the Fed's balance sheet increased by $392 billion:
https://fred.stlouisfed.org/series/WALCL

There seems to be something there other than SVB, and other than BTFP.

[daverobev]

Any of the banks looking attractive now?

FHN... looks pretty decent, presumable a good few percent below tangible book value per share. Where does one go to get good analysis?

FHN-PF above 8% too...

[chasesfish]

Any of the banks looking attractive now?

FHN... looks pretty decent, presumable a good few percent below tangible book value per share. Where does one go to get good analysis?

FHN-PF above 8% too...

I own a significant amount of the FHN-PFs

I sold out of FHN @ $13.  It's interesting to buy back below $10.   There are some screaming deals in smaller banks if you can avoid the toxic bond portfolios.  It's deeper than just "do they have securities", the MBS portfolios are far better than the treasuries in this environment.   Prepayments + regular amortization instead of interest only with a balloon payment at the end.   They disclosed a large charge off in a deal that rocked a few banks in Metro Atlanta, I want to see their earnings release and conference call to hear more about that.   

Five Points released their newsletter yesterday if you're interested.

https://fivepoint.substack.com/p/october-the-path-ahead-for-credit

[chasesfish]

Bought some Associated Banc (ASB) Preferred Stock today.

Locked in an 8.57% yield if they make it....

[daverobev]

Bought some Associated Banc (ASB) Preferred Stock today.

Locked in an 8.57% yield if they make it....

Too much FHN-PF already?

[chasesfish]

Bought some Associated Banc (ASB) Preferred Stock today.

Locked in an 8.57% yield if they make it....

Too much FHN-PF already?

Yes.  I'm close to $30,000 in FHN.   Spreading out the next purchases across 9-10 different banks between $3,000 and $5,000 at a time. 

[ChpBstrd]

Locked in an 8.57% yield if they make it....

I'm watching these yields go up and feeling really torn on the "if they make it" part.

On the one hand, these preferreds are like very-high-yielding non-callable bonds with a long time till maturity, just a bit riskier. The only time in the past couple of decades (AFAIK) that one has been able to build a portfolio over 7% has been times like the GFC, the initial COVID outbreak, and now. If the plan was ever to lock in preferred yields and sail into the sunset, one should not expect to obtain these yields during a time when everything seems clear and there are no worries. On the contrary, you have to buy when the sky is falling and reap the rewards after the recession is here and people start thinking about rate cuts again. The BTFP has stabilized things so far, so maybe banks will suffer through the next 3-4 years mostly in the red and working off the previous decade of malinvestment, paying those preferred dividends all the way.

On the other hand, we've suddenly been thrust into a middle-range rates environment after a dozen years of bad business investments and loans that only made sense when rates were lower. You know... the 3-5% ROA stuff, including business expansions, real estate projects, refinancings of now-empty office buildings, and 3% mortgages on houses whose value went up 50% in a couple of years. Banks will bear the brunt of this correction, and they've just been dealt fresh damage to their bond portfolios from rising long-term interest rates. Nobody's earning their cost of capital anymore. These entire bank portfolios are impaired - the bonds, the loans, and even the collateral - anything a bank could own is worth less than before do to a higher discount rate. A bet on banks now feels like a bet that rates will suddenly fall without a recession. So why not wait a bit longer to see what happens rather than jumping into the epicenter?

Still, preferreds of maybe too-big-to-fail blue chip banks like BAC-E, RF-E, RF-B, HBANP, and USB-P are all yielding >7%. How tempting is it to take a 5% WR retirement and to let the remainder cover inflation, as the 5 year breakeven is still only 2.17%?

[chasesfish]

@ChpBstrd COF-L just hit 7.12% if you want another one approaching TBTF size.

At this point I'm going to spread this around, I may very well be the bag holder on one or two issuances that go under, but in exchange I'm buying some of these $25 par issuances at $5 - $10 discounts and should earn back the loss via capital appreciation on the others.

I completely agree with you, it's rare you can get 7%+ on relatively low risk fixed income.   The forever question when buying in these environments will be:  Is it cheap enough?

I'm more positive about the outlook than you are, I think we're approaching terminal deposit cost and most of these organizations have the margins to absorb losses.  Many of the banks with "issues" have issues because they didn't take credit risk.  They have old, low cost deposit franchises and got lazy at being good lenders.  Instead they put those deposits into low risk, low yielding bonds and have margin issues to work themselves out of.   
 

[ChpBstrd]

@chasesfish on the question of "is it cheap enough" I guess I have it in my mind that the low point will be accompanied by headlines, hysteria, and hopelessness. In hindsight, early May was a great time to buy, and that was the environment at the time.

Instead, 2023 has turned out to be a year of only four bank failures. It's been remarkably quiet, given the losses in bonds.

This quote from a recent article makes me think we should expect the sort of outcomes that occur 1% of the time:

Over the last 2-, 5-, and 10-year rolling periods returns for long-dated Treasuries have been better more than 99% of the time. Only returns over the last year for this index are above the first percentile for historical returns.

According to Bespoke's data, annualized total returns over the last 1-year, 2-year, and 5-year periods are now negative for investors in long-dated Treasuries. Investors in long-dated Treasuries have experienced annualized losses of 17.6% over the last two years. In the last 10 years, these returns are just barely positive, clocking in at 0.8% per year.

Apparently, CRE refinancing deals are still going through at >7% rates, mortgage and CC defaults are low, and banks have so far been able to patch their massive bond losses by utilizing the BTFP. Stubborn housing prices and low unemployment seem to be rescuing the banks so far, but these last legs of the stool could all change in a few months.

The question of whether we're "approaching terminal deposit cost" is a good one. I was calling the top back in May, but since then we've had a hike to the FFR and a sudden rout in longer-term bonds. Banks that were offering 4.75% for multi-year CDs in May are now forced to pay 5.6% or more. Any banks that took my advice to lock in long duration treasuries last spring have taken a massive hit on those positions now. It's interesting to be wrong, even as a couch quarterback.



If the yield curves continue to uninvert, banks will experience losses on their long-term bond portfolios equal to or greater than the losses we were talking about in March-April. Yield curve un-inversion is also something that typically occurs right as a recession is starting - though it has usually been the short term end falling rather than the long term end rising.

Banks should be in trouble, but it's very quiet so far. I was eyeing some Comerica bonds yielding over 8% yesterday, but their ROA is only 1.46%. At that rate, it will take them a very long time to work off any bond losses, even if defaults on everything else hold up. Regarding COF, they have an ROA of only 1.17%. It makes sense for these companies to deleverage, as their capital structure is geared for a low interest rate world. Unfortunately they can't - their cash flow is needed to shore up ratios and of course pay dividends as FRC was doing right up till the bitter end.   

A portfolio of preferred shares yielding 7.5% can quickly become a portfolio yielding far less than treasuries in the event of a few collapses or dividend suspensions. Whether or not a preferred portfolio does better than a 5% treasury bond probably depends on exactly where the lightning strikes and exactly which shares one owns.

[chasesfish]

You make a lot of good points, I only have a few follow ups

- Much of your analysis is based around bank common stocks (ROA, mismatched returns).   I need survival for a preferred bet to pay off.    The typical dividend "suspension" in distress is to move the common to a penny and pay the prefs.    Regarding the common stock analysis (IMO), 1% ROA is an adequate for a bank.  That can equal a 12% return on equity with an 8% TCE ratio.   If you can buy a common below book doing that, 15% a year going forward is a nice return. 

- I'll be watching the various banks report this quarter.   4% to 5% on the bond portfolio is less of a hit than moving from 2% to 3%.   The rate of change / convexity is lower, so the mark isn't as bad.   The devil is in the detail when it comes to MBS holdings vs. Treasuries.   MBS have normal amortization and prepayments helping them, vs. the banks that are in long duration treasuries paying only interest with a balloon note at the end.

- Watch what the regulators do with the Hawaiian banks and Schwab.  They are the largest offenders of when it comes to any math of "what's their true equity if you mark all the duration losses to market".    They are the largest offenders by a large margin.  I traded the BOH prefs, but did not hold them long term. 

[ChpBstrd]

- Much of your analysis is based around bank common stocks (ROA, mismatched returns).   I need survival for a preferred bet to pay off.    The typical dividend "suspension" in distress is to move the common to a penny and pay the prefs.    Regarding the common stock analysis (IMO), 1% ROA is an adequate for a bank.  That can equal a 12% return on equity with an 8% TCE ratio.   If you can buy a common below book doing that, 15% a year going forward is a nice return. 

True. We can't think of ROA as a spread between deposit costs and a fixed basket of assets because that basket is constantly changing. Spreads can stay the same even as the deposit costs and the yield on the basket rise together. Matched-duration assets and liabilities can maintain the spread even in fast-changing times like these.

However, I suspect a lot of corporations - and banks especially - reached for ROE over the past dozen years via leverage and/or had only low-ROI investment options to make (e.g. ill-advised loans). So when I look at ROA, I am asking "does this business make sense any more at a fundamental level, or is it incapable of earning today's higher cost of capital?" I'm looking ahead to when they have to refinance their debts, pay their CD holders higher interest, pay the BTFP more interest, etc. I'm very interested in arguments or evidence contrary to this basic concern.

In terms of the survival / non-survival dichotomy, you're technically right, but in risky territory. Just one AIG or Lehman Brothers could knock out the returns of one's preferred stock portfolio. E.g. if 4/5 preferred stocks eventually go from 20 to 25, and the fifth goes to zero, one's price return is zero.

- I'll be watching the various banks report this quarter.   4% to 5% on the bond portfolio is less of a hit than moving from 2% to 3%.   The rate of change / convexity is lower, so the mark isn't as bad.   The devil is in the detail when it comes to MBS holdings vs. Treasuries.   MBS have normal amortization and prepayments helping them, vs. the banks that are in long duration treasuries paying only interest with a balloon note at the end.

I suspect the flipside of low home sales and rapidly rising mortgage rates is that prepayments will come in below historical norms (I'm certainly not sending an extra penny on my 3.25% debt!). That would effectively increase the duration of low-rate MBS and increase their convexity, compared to original expectations. This is only a hypothesis and I am interested in any evidence either way.

A world where borrowers are not prepaying their pre-2021 loans and moving their deposits from checking/savings accounts to money market accounts puts banks in a bind. They'll have to borrow money at higher rates than the loans to hold many of their loans to maturity. And there's no easy way out of that because they're leveraged to the max already. The alternative to losing money is to recognize losses. Not a good spot to be.

- Watch what the regulators do with the Hawaiian banks and Schwab.  They are the largest offenders of when it comes to any math of "what's their true equity if you mark all the duration losses to market".    They are the largest offenders by a large margin.  I traded the BOH prefs, but did not hold them long term.

Because of their reliance on treasuries? We could be approaching the point of maximum damage there.

I'm looking at mortgage rates around 7.5% combined with still-low housing affordability and wondering how long the MBS and CRE sides can support losses on the treasury side. It seems like prices are where they are solely due to <4% unemployment. Can the market sustain these prices at these rates if unemployment goes to 5%? Or would that set off a wave of home selling and foreclosures?

Round 2 after the banks' treasuries portfolios have been ravaged might be a wave of defaults, and such a one-two punch might topple some of the banks that survived rate hikes by keeping their treasuries in HTM accounts. Rising defaults might exceed banks' remaining BTFP collateral, and force some banks into recognizing more losses in HTM accounts, which becomes a domino effect potentially leading to more bank runs. If their BTFP collateral has been exhausted plugging the holes in their treasury portfolios, what plugs the holes in the lending side?

Maybe the world doesn't work this way, and I'm definitely looking for counterpoints. Sometimes the best counterargument is that the economy always does something unexpected and unprecedented. A soft landing would be exactly those things!

[chasesfish]

Here's the best data I've seen so far sourced from the National Mortgage Database - The percent of the country with mortgage rates below 4%.

https://x.com/Jeff_Tucke/status/1708153128993047036?s=20

Normal amortization should have reduced that percentage from 76% or so to 73-74% over the roughly 18 month time period.   Instead it sits at 66%.

Each month 400,000 homes still sell, with the new borrowers having today's rates.   Prepayments still happen from sales where the homeowner *needs* the equity for the new house vs. keeping it as a rental, then there's still the benefit of lump sum paydowns due to the after tax, risk free return it yields. 

Schwab / BOH have some of the lowest loan to deposit ratios and took the most duration risk with the excess deposits they tossed into securities.   Bank of America owns the largest "underwater portfolio", but it is only 1/6th of the bank in terms of total assets and it's mostly mortgage backed securities.  I

[chasesfish]

It's that time again!   Earnings season.  We'll talk about some important large banks to give an idea of how the US based regional and community banks will perform. 

First up is Wells Fargo.   Wells is a good marker on the United States, the bank has less noise from things like wealth management, investment banking. 

Summary:  A giant nothing burger.

Net Interest Margin:   Down slightly, with the pace of change down.  3.03% net interest margin, down from 3.09% last quarter and up from 2.92% from the same period last year.   Total loan yields of 6.23%, meaning deposit costs ran 3.2% all in.   I expect this to reverse and trend up slightly into next year.

Problem loans / allowance for credit losses:  Those who are waiting for a recession will have to wait.  I expect this to be a theme for a few more quarters.   Chargeoffs moved from 0.32% to 0.36%.   Wells has been building reserves for the last four quarters and loan balances ticked down this quarter.  This quarter they slowed the reserve build.  Last quarter they added nearly $1bil to reserves, this quarter they added just under $350mil.    No one is releasing reserves yet, which is a nice "all clear" signal, but slowing reserves is a little optimism vs. the prior four quarters of ever increasing reserve builds.  Remember you can only do so much "reserving" before the IRS comes calling.  WFC may be pushing the ceiling on this.

The allowance for loan losses to total loans is up to 1.60%, up from 1.40% from the same quarter last year.   

Debit card and point of sale data still shows no signs of a consumer slowing.   The only consumer data that looked interesting was auto loan originations were way down.

My summary on this:   The earnings report reads "we've been preparing and preparing for a storm, we prepared a little bit more, but things still aren't getting bad"

[chasesfish]

PNC - Another nothing burger.

PNC has more of a securities overhang than Wells Fargo and a smaller consumer business, but with that a lower level of problem loans.   Net interest margins declined slightly and are probably reaching their narrowest margins.  Terminal deposit costs look like they're hitting here.  Credit quality is still good here, well below normal chargeoff levels.  0.15% of assets while they are reserved at 1.7% of loans. 

The story here is a bunch of tailwinds that could be good for the business against the question of what happens when credit quality finally deteriorates some.

I just can't find something to be negative about on these two.

[ChpBstrd]

Appreciate the updates @chasesfish. Sounds like more support for the healthy economy narrative, although rates fell today as people continue fleeing to the safety of long-duration bonds and writing off the possibility of a November 1 rate hike.

It might be wiser for governments to raise regulatory caps on loan loss reserves when interest rates have recently risen by a certain amount within a certain timeframe. The same banks (and stock/bond holders) who the government is preventing from raising funds now might be needing a government bailout a year from now.

[chasesfish]

If you want to see what a bad bank earnings report looks like, I present $HIFS

https://www.hinghamsavings.com/assets/2023/10/PRESS-RELEASE-Q3-2023.pdf

Basically an bank that operated their company like unhedged multifamily mortgage REIT

[chasesfish]

Bank of America - another nothing burger

Net Interest Margin increased slightly, it looks like their terminal deposit costs are going to settle in around 1.55% and had a slight uptick in total deposits. Charge offs and loan loss reserves increased, but till below 2019 levels.  Margins should continue to increase +/- the pace of loan loss reserves.


You'll see headlines about "unrealized losses of X billions".   This is my largest holding, those unrealized losses only matter if deposits run.  Right now the bank has a 2.11% spread that's now increasing between it's cost of deposits and asset yields on a conservative loan / securities book

[ChpBstrd]

30 year treasury bond yields hit 5.00% today.

5 year rates were 4.92% today and 10 year were 4.91%.

30y mortgage APRs averaged 7.75%.

Question: Have we crossed the point of no return regarding either an eventual CRE crisis or the bursting of the housing bubble?

[reeshau]

Question: Have we crossed the point of no return regarding...the bursting of the housing bubble?

Not until homebuilders lose the ability to arbitrage mortgage rates vs. home prices with buydowns.  Last quarter, multiple homebuilders said they were getting about 200% return on mortgage buydowns, because of the focus of buyers on monthly payments.  One specific comment, although I would have to search back for the reference, was that a buydown costing $30,000 was worth the same to buyers as an $80,000 drop in home prices.  as long as homeowners don't or can't resort to that, it's a pretty lucrative niche.

[chasesfish]

Agree with @reeshau - Homebuilder margins are still higher than pre-pandemic and will likely get some material / labor easing, especially since multifamily deliveries are finally exceeding starts.

The 4.91% 5yr treasury isn't good.   There will be an overhang to earnings as the traditional banking sector works through their CRE.

I would be careful with the monoline mutlifamily lenders / commercial mortgage REITs (Redwood REIT, Arbor Realty, ReddyCap).   They took the most risk this cycle and there will be plenty of cash-in refinances or sales. 

So far, occupancy has held up strong in all asset classes except high rise buildings.   Rent growth is slower, expenses are up some, but these aren't distressed assets.  The assets could be overleveraged, but that's a sponsor / lender issue vs. a true distress sale / price collapse.   I fully expect good banks to have a 3.25% margin and be charging off 0.75% to 1% of their loans.   

The forever question is....are the common stocks of banks cheap enough to represent that reality?  YMMV   

[chasesfish]

If you want to see behind the scenes on running a (good) bank, take a look at this presentation.   There's so much insider baseball here

https://s25.q4cdn.com/259938676/files/doc_presentations/2023/PNFP-Earnings-Call-Slides-for-Posting.pdf

Also an incredible buy if you can ever find it at Tangible Book Value again.  I bought my position right around there earlier this and TBV is currently $48.78

[ChpBstrd]

If you want to see behind the scenes on running a (good) bank, take a look at this presentation.   There's so much insider baseball here

https://s25.q4cdn.com/259938676/files/doc_presentations/2023/PNFP-Earnings-Call-Slides-for-Posting.pdf

Also an incredible buy if you can ever find it at Tangible Book Value again.  I bought my position right around there earlier this and TBV is currently $48.78

Thanks for the link and congrats on successfully buying the dip!

PNFPP has been on my preferreds watchlist for a while, but I assumed they were in poorer condition if the shares were yielding 7.74%. I suppose I need to adjust my expectations! Something to like about PNFP is the relatively low 1.29% dividend is on the common stock. This is a superficial sign of a company keeping their powder dry. PNFP's reliance on muni bonds has worked well so far, but they are certainly not yet reporting any stress to their CRE or MBS portfolios. This is the first preferred I've been tempted to buy in a long time.

A long time ago, I said I'd have to jump in when a fairly safe and diversified preferred portfolio yields 7.5%. Well, we're getting very close, and inflation is only falling. PFF and PGX, two of my benchmark funds for preferred yields, are at 7%. A person could string together PNFPP, OZKAP, RF-C, HBANP, GS-A, FNH-C, NYCB-U, and more to obtain over 7.5% right now, with most of those shares significantly below par. Then one could throw in some PFFD and PFXF for diversification  The case for doing so is that these shares could rocket if something breaks amid the recent long-term yield shock, sending long-term yields immediately down, taking preferred stocks with them. The problem with such a narrative is that if anything breaks - defaults in any area, a sudden increase in unemployment, another financial institution going insolvent, etc - it would probably hit these same banks!

There's a case for a November-December debt ceiling standoff (led by who knows? - but any House speaker really) that could cause another interruption in the issue of new treasuries, suppressing long-term yields. Then if we have a weak holiday season followed by rising unemployment, peak long-duration interest rates will have passed us by. For the same reason preferreds appeal to me, I'm looking at some of the extra-high convexity treasuries available right now. They wouldn't offer the income and attempt-immediate-retirement potential of preferreds, but they'd be a lotto ticket bet on chaos sometime in the next few years and I like that. In another GFC situation, you could hop out with massive capital gains and hop into suddenly-affordable stocks.

/rambling

[Michael in ABQ]

My current portfolio of preferred stocks (PACWP, OZKAP, & BOHPRA) is right at 10% yield overall since I picked up some several months ago when the prices really dropped. Alas, my overall position is so small it's going to yield less than $100 a year.

[chasesfish]

@ChpBstrd Not rambling at all, I love this stuff.

$PNFP has never paid much of a common dividend, they reinvest all their capital into growth and haven't had an outside capital raise since 2016.    I'm also impressed with them taking a balanced approach working through some bond losses in exchange for higher yields whereas some of the competitors are sticking their head in the sand and saying "these are just paper losses".   I bought more prefs today because I think it's a good risk/return profile at 7.5%+

PNFP's knock relative to competitors is their cost of deposits are around 3% vs. 2% - 2.5% for other regional competitors, which is partially offset by having a smaller branch footprint and the lower non-interest expenses that go with it.   

This is a founder led bank and love the detail they provide.  It's a management team that believes in sharing everything.   This was the toughest quarter the bank has experienced in a while.

[MustacheAndaHalf]

PNFP's knock relative to competitors is their cost of deposits are around 3% vs. 2% - 2.5% for other regional competitors, which is partially offset by having a smaller branch footprint and the lower non-interest expenses that go with it.   

PNFP trails the S&P 500 over most time frames.

https://www.morningstar.com/stocks/xnas/pnfp/trailing-returns
https://www.morningstar.com/etfs/arcx/spy/performance

Maybe the case for PNFP lies in the past 3 years (+19.69%/year) despite the prior 12 months (-19.53%).  I can't find a website with yearly stock performance for PNFP, so I had to calculate what happened myself.  I think its two years of +46%/year followed by one year of -19.53%, which results in the 19.69 average.

Alternatively, buying iShares US Financials ETF (IYF) meant holding 140 companies instead of just one, and had better performance over the past 5-15 years.

[chasesfish]

Valuations matter.

You can't purchase / hold banks at 3x tangible book value, which Pinnacle got up to at one point.

[ChpBstrd]

PNFP's knock relative to competitors is their cost of deposits are around 3% vs. 2% - 2.5% for other regional competitors, which is partially offset by having a smaller branch footprint and the lower non-interest expenses that go with it.   

I noticed they are collecting most deposits from interest-bearing sources, which makes their margin all the more impressive in my mind. While other institutions seem to be taking a hunker-down approach and letting their non-interest-bearing (NIB) deposits bleed down, PNFP appears to be aggressively soliciting - and at a cost. They are trading growth for the risk that their asset performance, and margins, suddenly go negative while they are simultaneously paying a lot of interest to own those assets.

Yet the observation raises questions about what happens if and when rates come down. Does money flow back into NIB accounts? Or have people permanently changed habits regarding leaving large amounts of money idle in their checking accounts like they used to do? If the former, PNFP might have to choose between shrinking or lowering their standards in a world where credit spreads are lower. If the later, then PNFP might out-grow competitors who are still dependent on the NIB account model.

[chasesfish]

The answer to that is banks go back to being variable rate borrowers and variable rate lenders.

Where many got upside down is assuming the NIB accounts last forever.   Prior to 2007, most banks funded with a combination of CDs and savings accounts then had 15-20% NIB accounts.   I think we go back to that.

The banks then need to match up their fixed rate loans with CDs and variable rate loans with savings account products.

$FFIN had their trashfire of an earnings release.  They steadily bleed off NIB accounts by 7-9% per quarter yet the stock is priced like they'll be 35% funded by that forever.

[reeshau]

Does money flow back into NIB accounts? Or have people permanently changed habits regarding leaving large amounts of money idle in their checking accounts like they used to do?

I don't attribute either to habit, but inertia.  For that reason, I do think people will keep accounts already opened to chase yield.  I expect they will generally close / consolidate as the inconvenience becomes apparent, or as they need to spend those funds.

[Michael in ABQ]

Does money flow back into NIB accounts? Or have people permanently changed habits regarding leaving large amounts of money idle in their checking accounts like they used to do?

I don't attribute either to habit, but inertia.  For that reason, I do think people will keep accounts already opened to chase yield.  I expect they will generally close / consolidate as the inconvenience becomes apparent, or as they need to spend those funds.

My credit union pays effectively 0% interest on my checking account but I typically only have a few thousand dollars in there at a time to pay regular bills. It's just not worth changing around dozens of financial connections to chase a few percent yield on that relatively small amount of cash. However, any emergency fund or savings accounts are definitely going to be in a high-yield account earning 4-5%.

[reeshau]

Personally, I'm anticipating the stories that are going to come out about people who bought 0% fixed i-bonds when the inflation portion was high and only get around to cashing them in years after they were interesting.

[chasesfish]

Does money flow back into NIB accounts? Or have people permanently changed habits regarding leaving large amounts of money idle in their checking accounts like they used to do?

I don't attribute either to habit, but inertia.  For that reason, I do think people will keep accounts already opened to chase yield.  I expect they will generally close / consolidate as the inconvenience becomes apparent, or as they need to spend those funds.

I can give my opinion on this.  Industry wide you'll see it trend down, maybe the deposit mix goes to 15% to 20% NIB accounts vs. 30%+ post 2020.

The deposit mix / who are your customers is so important here.  The small business customer with a lot of money moving around but averaging $50,000 to $200,000 are incredibly valuable accounts.  They don't require interest and pay a little bit for some advanced services.   Also (generally), the older the bank and the more rural the bank is, the higher the NIB accounts are.

Personally I'm invested in a number of small, 100+ year old rural community banks that fit this profile.   Not only can they make good money at 5%+ bond yields on a low cost deposit base, but they'll be worth a nice premium to book for the banks that need funding. 

As much as I rag on $FFIN's terrible securities book and operations, they still trade at a huge premium because 32% of their deposits are non-interest bearing.   They are *the* bank in all these small central texas towns.

[ChpBstrd]

Simmons First National Corp (SNFC) is a bank I watch. It is a 120-year old institution with a rural base and a 114-consecutive-year history of dividends. At a $1.8B market cap, it's selling at 55% of book value. Their latest earnings report was a stinker IMO even though it beat estimates. Shares fell about 7% on the news:

-Revenue down 17.1% YoY
-Net interest income down 6% YoY
-Net interest margin down 21.9% YoY
-Non interest income down 0.47% YoY
-"continued customer migration to higher rate deposit products and pricing measures instituted to defend market share"
-Non performing assets up 42.7%, but still to only 0.32%.
-Notes of reduced employee salary and benefit costs.

Perhaps SFNC is the opposite of PNFP: it's a bank that's selling its ability to grow to cover poor operational performance and to buy itself out of the BTFP pawn shop.

[chasesfish]

SFNC - Now that's a nice recommendation.  I like what I see.

- Reducing salaries instead of growing loans when below TBV
- In "bond jail", but securities portfolio now yielding above 3%.   The pace of the bleed is slowing and many other banks are still stuck in the 2.4% to 2.7% on the securities book
- Above 7% TCE and defending their stock with a low level of repurchases
- Conservatively provisioned.  1.3% of loan book is about as conservative as I've seen, likely because of the previously discussed IRS issue
- 50% payout ratio at reduced earnings levels.   Capacity to grow Tangible Equity and/or handle loan losses if they come up.

Issues?

- The decline in NIB accounts is peerish.  Would like to see this slow bleed stop
- Deposit costs jumped 0.51% to just over 3%.   That's PNFP level costs and above all the peers.   
- Net interest margin declined (0.15%) while the average bank is flat.  This is within the range of outcomes I see, but on the bad side.
- The $3.7mil HTM book is an outlier on this size bank similar to $BOH.  Most just put all the securities in AFS and mark the book.   Right or wrong, this is what is creating the 50% of TBV discount because peer banks are marking everything.  TCE ratio if they mark the HTM book probably puts them in the 5.5% TCE ratio vs. the 7%+ you'd want.   The counter argument is all the bank's goodwill isn't marked either and billions of dollars in a 120yr old bank would be "marked up" if we're talking about market value.
- The securities book duration is still 7.2 years, which is longer than peers.  Advantage is they get 3%, challenge is they will recover the losses slower.  There is more convexity here *if* rates fall. 


My conclusion:  I'd put some money in this.   The bank has a bit of an earnings anchor due to the size of the securities portfolio ($7bil in 3.06% yielding assets funded by 3.01% funding costs) but they recognize this (salary reductions) and are taking actions vs. others that stick their head in the sand and say "paper losses" and "rates will go down"   They trade at a discount for a reason, but from everything I see the bank has quality in their assets and is working through the issues.   Things should reverse and improve in the next

[reeshau]

Simmons bought Spirit of Texas Bank last year.  My son was sad to see the giant Texas flags go.  To the extent they are developing in Texas, that is changing the client base of Simmons:

"Spirit ranked among Fortune’s 2021 100 Fastest-Growing Companies. With the completion of this acquisition, Simmons has approximately $28 billion in assets, $14.3 billion in loans and $22.1 billion in total deposits based on data as of December 31, 2021. In Texas, the addition of Spirit will more than double Simmons’ size and scale with footings totaling approximately $4.8 billion in loans and $4.9 billion in deposits based on data as of December 31, 2021, while increasing the number of branches to 57, located primarily in the fast-growing Texas Triangle."

[grantmeaname]

After the Fed press conference today, the 5yr Treasury is at 4.57%.

That exceeds the *pain* threshold on many commercial real estate deals.  If it closes above this level at quarter end, expect the bond mark discussion for the banks to resume as they report earnings in mid October.   You'll likely see problem loan reserves increase and expenses start to increase, I expect they'll start appraising properties early of the maturity date and increasing reserves on any 2024 maturities.

There was a great Exchanges at Goldman Sachs episode on this earlier this week. I thought the second speaker, Stijn, was fantastic (first speaker was just so-so). highly recommended listening - how big are the losses, what does it mean for each level of the cap structure, how is this similar or different to the S&L crisis?

[ChpBstrd]

IDK... I perceive SFNC as a bank that theoretically should have advantages but is somehow squandering the opportunity. I.e. they should have a lower cost of deposits given their customer base, but it sounds like their customers are actually quite flighty, moving their NIB account balances into CDs or competitors. As a result, non interest bearing deposits to total deposits ratio has fallen from 28% last year to 22% this year.

Most or all banks are having this problem, and maybe SFNC's performance is comparatively OK. Yet SFNC seems to contradict the narrative that established, deposit-centric banks with lots of small depositors can hold onto their NIB deposits and margins in a high interest rate environment. Their overall performance seems similar to Bank of America in terms of NIB deposit flight, bad loans, and loss provisions. Nothing special to see here.

Even worse, customers are not moving their NIB deposits into IB accounts at Simmons First!  "Interest bearing transaction accounts and savings deposits" fell from $12.1B last year to $10.57B this year, suggesting the bank's interest-bearing account products are not competitive. Customers are at least moving money into time deposits, which was the only area of growth under the deposits heading, but it's just driving up the cost. SFNC is facing a situation where they're in part covering a 3% yielding investment portfolio with 5.2+% CDs and 5.5+% BTFP loans. At least that portfolio is less than half the size of the loan book, and at least almost half of investments are marked AFS.

SFNC's interest expenses increased by $119.82M YoY while interest revenue only increased $79.67M. With that 50% difference in growth of expenses versus revenue contradicting any notion that rising rates might be good for banks. Their loan and securities portfolios are a lot stickier than their deposits, and that's leading to margin erosion. People are moving their checking account surpluses into CDs and not prepaying their low-rate loans.

That said, something to like about SFNC is their efficiency ratio. Since last year this increased to 65% from an already good 57% as they eliminated 201 employees. This may be an effect of digesting Spirit of Texas, as @reeshau pointed out. So maybe their operations aren't as inept as I perceive, but I do think they're badly positioned.

The best hope for banking in general right now is the steady un-inversion of the yield curve. Unfortunately, this does not tend to happen without a recession, and loan-heavy banks like SFNC are vulnerable despite provisioning 4x their current loan losses. I predict the numbers will likely get uglier and the stock will be lower this time next year. Also, I suspect the endgame of SFNC's conservative management is to "buy banks on the dip" like they did with Spirit of Texas, so there could be value-destructive mergers in the future.

I'm just stretching to see the value proposition behind SFNC versus their larger competitors or simply a financials ETF. If SFNC's position is not delivering advantages and the whole sector is suffering, then maybe avoid the sector?. Most banks I look at appear to all be in the same boat.

[chasesfish]

@ChpBstrd It's just the same story, over and over with deposits and a long duration bond portfolio...

If a bank stayed short, they just let the highest cost depositors redeem, sell down some securities to pay them, and move on with life.

If they went long and management won't realize losses, they have to pay up for that last marginal dollar and reduce / stop making new loans at today's 8% margins.  That's an earnings anchor and at some point it is priced in.   SFNC is more priced in then it's Texas brethren $FFIN or the Hawaiian banks.

I expect a lot of management teams that aren't going to make their numbers realize some large bond losses next quarter to get better spreads going forward.