Are big banks value traps ?

[Spekulatius]

Despite Trump’s tweet asking for negative rates, it seems that the Fed itself is against them. both Powell and the head of the St Louis Fes strongly suggested such. In this case, I would go with what the Fed stated not Trump‘s tweet and that would actually take some tail risk for the banks off the table.

[UK]

https://www.bloomberg.com/opinion/articles/2020-05-08/coronavirus-markets-want-negative-rates-even-after-fed-gift

[Spekulatius]

Financial stability report from the Fed. It’s seems like the banks are Ok for now. Issues to worry about is commercial real estate and life insurers. I haven’t seen any report before indicating increased leverage and crappy assets with life insurers. interesting.

 

https://www.federalreserve.gov/publications/files/financial-stability-report-20200515.pdf

[meiroy]

"Leverage in the financial sector. Before the pandemic, the largest U.S. banks were strongly

capitalized, and leverage at broker-dealers was low; by contrast, measures of leverage at

life insurance companies and hedge funds were at the higher ends of their ranges over the

past decade. To date, banks have been able to meet surging demand for draws on credit

lines while also building loan loss reserves to absorb higher expected defaults. Brokerdealers struggled to provide intermediation services during the acute period of financial

stress. At least some hedge funds appear to have been severely affected by the large asset

price declines and increased volatility in February and March, reportedly contributing

to market dislocations. All told, the prospect for losses at financial institutions to create

pressures over the medium term appears elevated."

 

"The vulnerability stemming from elevated CRE valuation pressures, coupled with a dim

outlook for the sector as indicated by recent declines in equity real estate investment trust

(REIT) prices, suggests that CRE may undergo a substantial repricing in response to disruptions generated by the COVID-19 pandemic. For instance, since late February, the hospitality and retail sectors have experienced precipitous declines in demand because of social

distancing, putting the ability of these sectors to make timely mortgage and rental payments

into question. The non-agency commercial mortgage-backed securities (CMBS) market,

which had previously been funding about one-fifth of CRE mortgage debt, stopped new

securitizations toward the end of March. CRE loans that would normally be securitized have

been accumulating on bank balance sheets. In addition, data from the April 2020 Senior

Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) indicated that a major

fraction of banks reported weaker demand for CRE loans and tighter lending standards, on

net, in the first quarter of 2020 (figure 1-15)."

 

 

At the end of 2019, loss-absorbing capacity in the banking sector was at historically high

levels. This strength permitted banks to absorb the increased credit provisions and draws on

credit lines associated with the onset of the pandemic. Tangible capital at large banks—a

measure of bank equity that excludes items such as goodwill—changed little in 2019,

and regulatory capital ratios stayed well above their required minimum levels (figures 3-1

and 3-2). The Federal Reserve is currently conducting its 2020 stress test and conducting

additional assessments of banks’ resilience to the unprecedented economic shock caused

by COVID-19.

 

(2019 4Q) Leverage measured at life insurance companies using generally accepted accounting principles rose to post-2008 highs (figure 3-6). Moreover, the capitalization of the life insurance  sector is likely to deteriorate in coming quarters

because of lower-than-expected asset valuations and lower long-term interest rates. Insurance companies are also important investors in CRE, corporate bonds, and CLOs, exposing

them to risks stemming from sharp drops in asset prices, elevated issuer leverage, potentially rising defaults in the corporate sector, and funding illiquidity risks.

 

That was a good read. Thanks Spekulatius.

[rb]

(2019 4Q) Leverage measured at life insurance companies using generally accepted accounting principles rose to post-2008 highs (figure 3-6). Moreover, the capitalization of the life insurance  sector is likely to deteriorate in coming quarters

because of lower-than-expected asset valuations and lower long-term interest rates. Insurance companies are also important investors in CRE, corporate bonds, and CLOs, exposing

them to risks stemming from sharp drops in asset prices, elevated issuer leverage, potentially rising defaults in the corporate sector, and funding illiquidity risks.

So it looks like the LifeCos are holding the bag of shit this time around.

[thepupil]

http://baunefinancial.nm.com/files/78464/power_of_portfolio.pdf

 

Not sure how representative of the industry they are but Northwestern Mutual has nice and pretty brochure’s about their portfolio to get a feel for what life insurance co’s own and what their ultimate problem is (falling yields, which pushes them out the risk curve). Ultimately the majority of assets are IG bonds (but there’s lots of CRE mortgage exposure, though I would guess most probably attaches at 40-50% LTV). I am not sure how say losing 50% on a PE vintage or two that might be 1% of the general account or a similar percent on HY/CLO’s/levered RE would impact their position. For example, IG spreads have blown out, preserving all-in yields, which might help them preserve overall portfolio yield while taking some hits elsewhere (though I would expect some IG defaults too, so it’s very uncertain.

 

Anecdotally, my friend works for them and is doing increased business; people are seeking the stability /illiquidity of life insurance as they watch the stock rollercoaster.

 

I also think the Fed report does a good job of highlighting the size of the CRE market. With all this talk of “everyone’s moving out of apartments, not going to the office or mall ever again”, the fact that CRE is a $20 trillion asset class and far bigger than leveraged loans or HY should really make one think about the ramifications of all that. Working remotely forever and not going into the office will destroy banks, insurers, municipal governments that are highly  dependent on property taxes (all of them), etc.

 

Just because it is a terrible outcome, does not mean that it can’t happen; but a commercial real estate collapse is not REIT bag holders problem; it is society’s problem. The REIT market is like 2-5% of the large cap indices, but the CRE market is $20 trillion and comprises large portions of bank/insurance balance sheets. For perspective, crappy credit (leveraged loans and junk) is $2.4 trillion and the stock market is $38 trillion. This may seem a leap, but the stress in CRE is one of the reasons I can’t understand growth tech valuations; if you think that we’re going to see a bunch of banks/insurers/pensions/municipalities fail because of declining CRE and property taxes, and the populace is going to sit there and watch tech pay between 0% and 20% tax rates and enjoy several (beneficial and perfectly legal in my view) monopolies, I think that’s mistaken. The destruction that comes with what’s conteplated will be pervasive and all encompassing. Corporate earnings power will be assaulted, as will that of the wealthy: increased regulation, increased labor friendliness, increased corporate and individual taxes.

 

In some ways, we are all long offices and retail and apartments, even if you don’t own my shitty REITs or big banks

[thepupil]

In other news, in an example of the fake vol suppression that accompanies illiquid investments; the TIAA real estate account, which owns low leverage “core” real estate, some cash, and REITs, including 37% office and 20% retail IS FLAT year to date. TIAA’s general account guarantees liquidity to people who own QREARX.

 

This happened in ‘08 too, allowing saavy non profit workers to punch out and buy risk assets (or go to cash) at fake marks.

 

If anyone knows a teacher or professor or cop or whatever that might be long this, I suggest you get in touch with them and explain that a fund that is 57% office and retail should not be flat year to date and strongly recommend they sell (either to replace with REITs or hide out in something else that isn't so mismarked).

 

https://fluenttech.tiaa.org/pdf/factsheet/878094200.pdf

 

Check out the two largest investments, malls held alongside BPY and SPG.

 

Flat year to date, hah!

 

Fashion Show Mall: Fashion Show is held in a joint venture with Brookfield Property Partners LP, in which the Account holds 50% interest, and is presented gross of debt. As of March 31, 2020, this debt had a fair value of $417.9 million

 

Florida Mall: The Florida Mall is held in a joint venture with Simon Property Group, L.P., in which the Account holds a 50% interest, and is presented gross of debt. As of March 31, 2020, this debt had a fair value of $155.8 million.

[Spekulatius]

CRE seems to be an Achilles heel of the financial system. The report mentioned  low cap rates to start and now with COVID-19 the fundamentals have weakened substantially too. With a $20 trillion, the Fed May find It difficult to nail out the entire sector. We have seen the reaction of Public equity Reit already and it was swift and significant. If now the private market follows to the same extend, we will see a lot of naked bodies on the beach.

[meiroy]

https://www.cbsnews.com/news/full-transcript-fed-chair-jerome-powell-60-minutes-interview-economic-recovery-from-coronavirus-pandemic/

 

PELLEY: Are the banks sound?

 

POWELL: So after the last financial crisis, the banks more than doubled their capital and liquidity and they're far more aware and better at managing the risks they're taking. They're so much stronger than they were before the financial crisis, the last financial crisis. In fact, they were right at the heart of that. They were a key mechanism for amplifying bad things that happened. That's not the case at all now. They've been strong. They've done all the things you would hope they would do. Companies have pulled down their lines of credit. They've funded those. There's -- much more cash has flooded into the banking system as people have sold risky assets. And the banks have absorbed all of that. So the banks have been strong so far.

 

PELLEY: And for people who wonder whether they should take their money out of the bank and put it in a mattress, you tell them what?

 

POWELL: There's no need to do that. No need at all. The banks have been strong, they've been fine. There's absolutely no need to do that.

 

 

 

 

 

[LC]

From a financial systems point of view - this crisis has been managed very well. Powell is correct about that. People that dismiss all regulation should wonder where we would be now without 10 years of strict federal oversight and regulatory requirements on the large banks. And as another poster mentioned - capital returns to shareholders over that period have been very generous.

 

My guess going forward: All banks probably do fine on the April stress tests. Further tests will be done with revised stress forecasts above the SA and BHC stress scenarios, and increased monitoring will also be performed over the banks's portfolios. Not sure how much more incremental capital will need to be raised but I assume capital team & FRB will make those decisions probably around July.

[sleepydragon]

In other news, in an example of the fake vol suppression that accompanies illiquid investments; the TIAA real estate account, which owns low leverage “core” real estate, some cash, and REITs, including 37% office and 20% retail IS FLAT year to date. TIAA’s general account guarantees liquidity to people who own QREARX.

 

This happened in ‘08 too, allowing saavy non profit workers to punch out and buy risk assets (or go to cash) at fake marks.

 

If anyone knows a teacher or professor or cop or whatever that might be long this, I suggest you get in touch with them and explain that a fund that is 57% office and retail should not be flat year to date and strongly recommend they sell (either to replace with REITs or hide out in something else that isn't so mismarked).

 

https://fluenttech.tiaa.org/pdf/factsheet/878094200.pdf

 

Check out the two largest investments, malls held alongside BPY and SPG.

 

Flat year to date, hah!

 

Fashion Show Mall: Fashion Show is held in a joint venture with Brookfield Property Partners LP, in which the Account holds 50% interest, and is presented gross of debt. As of March 31, 2020, this debt had a fair value of $417.9 million

 

Florida Mall: The Florida Mall is held in a joint venture with Simon Property Group, L.P., in which the Account holds a 50% interest, and is presented gross of debt. As of March 31, 2020, this debt had a fair value of $155.8 million.

 

https://www.wsj.com/articles/when-your-lookalike-funds-dont-act-alike-11590159641?redirect=amp&from=groupmessage&isappinstalled=0#click=https://t.co/CBMF5IIYSB

 

I am willing to bet Jason Zweig is a member on COBF

[elliott]

 

https://thehill.com/policy/finance/504616-fed-bans-stock-buybacks-caps-dividend-payments-for-big-banks-after-stress

 

Cullen Roche:

Let me translate this for you. The Fed is very worried about the banking system.

[sleepydragon]

 

https://thehill.com/policy/finance/504616-fed-bans-stock-buybacks-caps-dividend-payments-for-big-banks-after-stress

 

Cullen Roche:

Let me translate this for you. The Fed is very worried about the banking system.

 

I don’t think the Feds are worried about the banking systems. The data says it all. Banks will need to lose a lot of money in the stress test scenario. We are still far from that. The whole point of stress test is the data is transparent. People can see banks have enough capital to weather the problem.

The dividends caps merely indicate that Feds admit they don’t know when the virus will ends, which shows Fed is rational. It’s also formula based so good banks can keep paying dividends but bad banks stops.

 

[wabuffo]

The massive expansion of the Federal Reserve's balance sheet since the Great Financial Crisis (GFC) has helped to increase the safety and soundness of the US commercial banking system.  I think that is an important aspect that most people miss when they think about this crisis vs the last major crisis (GFC).

 

Pre-GFC, (using the Fed's H.8 and H.4.1 reports for July 6, 2006 as an example of a point in time before the mortgage crisis), the US banking sector had $10.6B of reserves on deposit at the Fed vs $8.229t of total bank assets (0.1% of total assets).

 

By comparison, if one looks at the latest numbers (as at June 17th, 2020), all federally-chartered US commercial banks combined have $3.069t in reserve balances* at the Federal Reserve vs total assets of $20.246t.  So 15.2% of the entire US banking sector's assets are on deposit in cash at the Federal Reserve!  It really is night and day vs pre-GFC.

 

That's part of the reason for the repo mess last September, bank regulators are leaning on banks to use their deposits at the Fed as the primary asset to meet liquidity coverage ratios and "living will" requirements.

 

wabuffo

 

* the $3.069t of banking reserves on deposit at the Fed from the H.4.1 report matches the "non-seasonally adjusted bank cash assets" of $3.084t on the Fed's H.8 report.  The small difference is minor amounts of cash and vault cash held by the banks at their branches.

[Spekulatius]

As for Fintech, this is an interesting excerpt from RKT (Rocket Company) 424B:

Since our inception in 1985, we have consistently demonstrated our ability to launch new consumer experiences, scale and automate operations, and extend our proprietary technologies to partners. Our flagship business, Rocket Mortgage, is the industry leader, having provided more than $1 trillion in home loans since inception while growing our market share from 1.3% in 2009 to 9.2% in the first quarter of 2020, a CAGR of 19%. We have also expanded into complementary industries, such as real estate services, personal lending, and auto sales. In each of these gigantic and fragmented markets, we seek to gain share and drive profitable growth by reinventing the client experience.

 

Between mortgages and payments, it seems that some companies are running circles around the big banks, just like WMT, TGT and others did with department stores in retail.

I have personally done probably 8-9 mortgages (mostly refinances) and have all of them but two through brokers. In In my experience, brokers platforms now run circles around how banks are doing business. I only once tried with Rocket mortgage and did not find their interest rate / conditions to be competitive at that time (2015).

[wabuffo]

Between mortgages and payments, it seems that some companies are running circles around the big banks

 

They haven't made much market share progress this year.  But then these fintechs have to rely on traditional banks for both their wholesale financing as well as payment clearing.  Or they arb in between tiny cracks in the regs (e.g., debit interchange capped fees for large banks).  For example, mortgage origination has always relied on wholesale bank funding.  But if you are not a bank, you are always vulnerable to your funding being pulled.

 

When your competitor is also your supplier and is a monetary agent of the federal government (i.e., federally-chartered bank), I think its very tough to beat them.  Unless, the fintech is approved to also be a federally-chartered bank and submit to all of the Fed's regulatory apparatus.

 

wabuffo

[Spekulatius]

Between mortgages and payments, it seems that some companies are running circles around the big banks

 

They haven't made much market share progress this year.  But then these fintechs have to rely on traditional banks for both their wholesale financing as well as payment clearing.  Or they arb in between tiny cracks in the regs (e.g., debit interchange capped fees for large banks).  For example, mortgage origination has always relied on wholesale bank funding.  But if you are not a bank, you are always vulnerable to your funding being pulled.

 

When your competitor is also your supplier and is a monetary agent of the federal government (i.e., federally-chartered bank), I think its very tough to beat them.  Unless, the fintech is approved to also be a federally-chartered bank and submit to all of the Fed's regulatory apparatus.

 

wabuffo

 

These brokers own the customer relationship and associated data though. The Banks often do commoditized stuff like wholesale financing and mortgage servicing (which also provides an opportunity to get a customer relationship) but those are low ROA activities that just require large balance sheet capacity.

 

The future of Banks will be decided how strong their internal tech stack is rather than branches and deposits. In fact, in the current interest environment, low cost deposits have lost much of their value.

[Guest cherzeca]

"In fact, in the current interest environment, low cost deposits have lost much of their value."

 

while I tend to agree, if we ever do get into a rising rate environment, banks know how to raise loan rates more quickly than deposit rates...huge financial leverage possible with this huge deposit base

[Spekulatius]

"In fact, in the current interest environment, low cost deposits have lost much of their value."

 

while I tend to agree, if we ever do get into a rising rate environment, banks know how to raise loan rates more quickly than deposit rates...huge financial leverage possible with this huge deposit base

 

This is correct, but a better way to play rising interest rates in clean way is to buy SCHW (I own a little). No issues with credit risk, Fed interfering but somewhat sensitive to asset valuations. It’s higher valued but also a better business than banking, imo.

[LearningMachine]

This is correct, but a better way to play rising interest rates in clean way is to buy SCHW (I own a little). No issues with credit risk, Fed interfering but somewhat sensitive to asset valuations. It’s higher valued but also a better business than banking, imo.

 

Are you not worried about their history of dilutions from 2009 to 2018?

[Spekulatius]

This is correct, but a better way to play rising interest rates in clean way is to buy SCHW (I own a little). No issues with credit risk, Fed interfering but somewhat sensitive to asset valuations. It’s higher valued but also a better business than banking, imo.

 

Are you not worried about their history of dilutions from 2009 to 2018?

 

Dilution was about ~1% annually since 2012. That hardly breaks an investment thesis considering that they had some decent organic growth.

[LearningMachine]

This is correct, but a better way to play rising interest rates in clean way is to buy SCHW (I own a little). No issues with credit risk, Fed interfering but somewhat sensitive to asset valuations. It’s higher valued but also a better business than banking, imo.

 

Are you not worried about their history of dilutions from 2009 to 2018?

 

Dilution was about ~1% annually since 2012. That hardly breaks an investment thesis considering that they had some decent organic growth.

 

You're right dilutions slowed down in 2012.  Maybe I should rethink my mental model, but I find constant dilutions a sign of management willing to steal from shareholders, and that can show up in other ways also in not being shareholder friendly long-term, e.g. when push comes to shove, for management to save their jobs, if they need to dilute like crazy, they will do it.  Also, I don't like that they are so highly leveraged with a low CET1 - very close to being taken over by regulators if they get any losses.

[Spekulatius]

This is correct, but a better way to play rising interest rates in clean way is to buy SCHW (I own a little). No issues with credit risk, Fed interfering but somewhat sensitive to asset valuations. It’s higher valued but also a better business than banking, imo.

 

Are you not worried about their history of dilutions from 2009 to 2018?

 

Dilution was about ~1% annually since 2012. That hardly breaks an investment thesis considering that they had some decent organic growth.

 

You're right dilutions slowed down in 2012.  Maybe I should rethink my mental model, but I find constant dilutions a sign of management willing to steal from shareholders, and that can show up in other ways also in not being shareholder friendly long-term, e.g. when push comes to shove, for management to save their jobs, if they need to dilute like crazy, they will do it.  Also, I don't like that they are so highly leveraged with a low CET1 - very close to being taken over by regulators if they get any losses.

 

Well, I don’t like dilution either, but one needs to look in more detail. There are cash proceeds from stock Option excercises for example that reduce the effective dilution.

 

Some mature SAAS companies (WDAY being a prime example) dilute their shareholders by 6-7% annually through stock based comp - that’s really a significant economic impact.

 

As for Schwab though, I think the dilution has destroyed less value than WFC overeager share buybacks for example.

[fareastwarriors]

Federal Reserve Board announces it will extend for an additional quarter several measures to ensure that large banks maintain a high level of capital resilience

 

https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200930b.htm

 

Due to the continued economic uncertainty from the coronavirus response, the Federal Reserve Board on Wednesday announced it will extend for an additional quarter several measures to ensure that large banks maintain a high level of capital resilience.

 

For the fourth quarter of this year, large banks—those with more than $100 billion in total assets—will be prohibited from making share repurchases. Additionally, dividend payments will be capped and tied to a formula based on recent income. The capital positions of large banks have remained strong during the third quarter while such restrictions were in place.

 

In June, the Board released the results of its annual stress test and additional analysis, which found that all large banks were sufficiently capitalized. Nonetheless, in light of the economic uncertainty, the Board put several restrictions in place to preserve bank capital, which provides a cushion against loan losses and supports lending. Later this year, the Board will conduct a second stress test to further test the resiliency of large banks. Results will be released by the end of the year.

[Spekulatius]

Interesting fact about NIMs ( Q2/Q32020):

Lloyd ( UK ): 2.4%

WFC: 2.13%

BAC:  1.72%

JPM:: 1.75%

 

All those banks NIM are being reduced by a flood of deposits. BAC and JPM have a lot of non- interest income, WFC not so much.

 

Years ago, I looked at Brit and Irish banks and thought : “ Are banks with NIM < 2% really worth owning?”. Now here we are...