Bank Stocks Down, M&A Flat, Credit Costs Rising

Rough Week for Bank Stocks

Underperforming a down market. The S&P had a bad week, dropping 2.9%, but banks fared worse. The KBW Bank Index (BKX) fell 4.6%, and the KBW Regional Bank Index (KRX) dropped an even 5%. While the Fed paused as expected, the increasing expectations of a higher-longer rate environment weigh on a sector already burdened with credit quality concerns and a less than constructive regulatory environment. With a week remaining in 3Q23, banks also are poised to book a fresh round of sizable securities losses due to the 62bp QTD rise in the 10 year yield.

Figure 1: The KBW Bank Index declined 4.6% last week, underperforming the S&P 500 by 1.7%

Source: FactSet

Figure 2: The KBW Regional Bank Index declined 5.0% last week, underperforming the S&P 500 by 2.1%

Source: FactSet

Bank M&A Remains Subdued

More credit unions acquiring banks recently, however.  There were no bank acquisitions last week, and just 26 bank acquisitions quarter-to-date. Transactions have been not just scarce but small; the only transaction with a value exceeding $1 billion was the Banc of California - PacWest merger, which was more of a punctuation of the Spring liquidity crisis than a model for prospective deals, and the next-largest transaction was less than half that size. One noteworthy trend is the flurry of bank acquisitions by credit unions, of which there have been four this quarter, including three within the past month. 

Figure 3: 3Q23 announced bank M&A 

Source: FactSet

Credit Cards: Master Trust Data & Retailer Earnings Calls Highlight Deterioration

NCOs and delinquencies worsening year-over-year. Master trust data released on September 15 continued to reflect mean reversion from the unsustainably low levels of charge-offs and delinquencies seen during (and since) COVID. 

Retailer earnings calls highlight private label card pressures. On Nordstrom’s 2Q23 earnings call, CFO Cathy Smith noted that “we have seen delinquencies rising gradually and they are now above pre-pandemic levels which could result in higher credit losses in the second half and into 2024.” Similarly, on Macy’s 2Q23 earnings call, COO & CFO Adrian Michell stated “While we had expected delinquencies to rise as part of our normalizing credit environment, the speed at which the increase occurred for us and the broader credit card industry since our first quarter earnings call was faster than planned,” and outlined the impact on 2023 guidance: “The increased bad debt expectation for the credit card portfolio has resulted in a reduction in our annual forecast of roughly $80 million relative to our prior expectation.” While neither retailer is partnered with one of the stand-alone private label issuers—Nordstrom’s card partner is TD and Macy’s is Citigroup—these comments offer insight into the broader private label environment.

Figure 4: Credit card master trust net charge-off rates, annualized

Source: FactSet StreetAccount

Figure 5: Credit card master trust delinquency rates

Source: FactSet StreetAccount

Figure 6: American Express master trust net charge-off and delinquency rates

Source: FactSet StreetAccount

Figure 7: Bank of America master trust net charge-off and delinquency rates

Source: FactSet StreetAccount

Figure 8: Citigroup master trust net charge-off and delinquency rates

Source: FactSet StreetAccount

Figure 9: Capital One master trust net charge-off and delinquency rates

Source: FactSet StreetAccount

Figure 10: Discover master trust net charge-off and delinquency rates

Source: FactSet StreetAccount

Figure 11: JP Morgan Chase master trust net charge-off and delinquency rates

Source: FactSet StreetAccount

Consumer Headwinds

Excess savings dwindling, student loans resuming.  Extending out the San Francisco Fed’s analysis from arlier this year with more recent data, the excess consumer savings accumulated during COVID are, as of this writing, about fully exhausted. As of last month’s release, all but $95 billion of the $2.1 trillion in above-trend savings had been dissipated; the imminent release of fresh data is likely to bring that number close to zero. That doesn’t imply near-term catastrophe, only that the consumer’s margin of safety continues to dwindle as the FOMC more or less explicitly works toward a weaker labor market. Student loans have also resumed interest accruals, with payments to resume next week.

Recent wild cards. More recently, some wild cards have emerged for which we can readily infer the valence of their impact (negative) but can only speculate about the magnitude. The potential Federal government shutdown will presumably be limited in duration but can only produce drag in the short term. Oil prices are flirting with triple digits; we offer no price forecast, but the effect on consumers is obvious. The development with the largest potential long-term impact, however, may be the UAW strike.

The UAW strike. Based on the offers the UAW has already turned down, it seems clear that the members are going to secure significant wage gains. Labor is a small enough share of auto production costs that the impact on auto prices may be modest but the potential impact on broader wage inflation is less certain. The traditional wage-price spiral is ostensibly mitigated by the fact that so few private sector workers are unionized—just 6% as of 2022. That is scarcely one-third the level of 40 years ago, a figure that was itself scarcely one-third of the level of 25 years prior. Moreover, such pockets of the private sector as have seen union growth in recent years have tended to enjoy low levels of bargaining power. (Unions generally only augment the pre-existing level of bargaining power, which is immense for longshoremen, who can cripple global supply chains in an afternoon, and negligible for a lot of the hospitality workers organized by the SEIU. The UAW is somewhere toward the middle of that spectrum). And yet, wages in non-union shops can’t be completely detached from union wage rates (at least not if the plant owners want then to remain non-union). The impact on inflation, then (and even on private sector unionization) may not be as negligible as it seems at first glance.

Figure 12: SF Fed research suggests the excess savings accumulated under COVID will be dissipated by October

Source: FactSet

Interest Rates

Bear steepener continues to lessen curve inversion. The bear steepener remained in place last week as the 10-year yield hit another cyclical high. The 2 year - 10 year spread narrowed by 4bps to 66bps, driven by a 10bp rise in the 10-year yield to 4.43%. 

Figure 13: The bear steepener continues to flatten the curve

Source: FactSet

Figure 14: The 2-10 spread narrowed last week to -66bps

Source: FactSet

Fed Funds futures continue to discount higher-longer. Fed Funds futures forecast that the onset of Fed easing continues to drift further into the future, and the expected trajectory continues to flatten. Futures currently imply that the first rate cut will not come until the July 31 FOMC meeting, and that it will be the only cut between now and election day 2024.  

Figure 15: Fed Funds futures continue to turn less dovish

Source: FactSet

Figure 16: Fed Funds Futures imply the first rate cut has been pushed out to the July 31, 2024, FOMC meeting

Source: FactSet

Weekly Federal Reserve Balances

Federal Reserve borrowings flat. Total bank borrowings (BTFP combined with the Discount Window) were flat for the week at $110.7 billion, likely a brief pause in the slow, sustained climb of the past few months. Money market fund balances dipped slightly, down 13bps to $5.6 trillion. 

Weak loan growth, while small banks outperform large banks on deposits. Total loans in the banking system grew by 5bps and are tracking to 3% annualized growth for 3Q23. Total deposits declined 4bps last week, but the outperformance of small banks continued. Large banks saw a decline of 34bps and are down 0.41% QTD and 3.9% over the past year. At small banks, deposits fell 9bps, leaving them up 1.89% QTD, though still down 0.73% over the past year.  

Figure 17: Federal Reserve balances

Source: FactSet

Figure 18: Bank Term Funding Program usage reached another new peak last week

Source: FactSet

Figure 19: Money Market Fund assets dipped by 13 bps last week

Source: FactSet

Figure 20: Deposits fell slightly last week

Source: FactSet

Figure 21: Total loan growth remains very sluggish

Source: FactSet

Figure 22: Large cap bank performance and valuation

Source: FactSet

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