U.S. regional banks two-point-Oh!
We appear to be witnessing a shift in the U.S. banking landscape and recent events suggest we should proceed with caution.
In perhaps an echo of the March 2023 undercapitalisation and investment losses banking saga that affected Silvergate Bank, Silicon Valley Bank, and Signature Bank, S&P Global Ratings recently downgraded five major banks and revised the outlook for two others.
Among these, KeyCorp stands out, with assets worth almost US$193 billion. Other banks, including Comerica Inc. and UMB Financial Corp., collectively hold assets approximating US$427 billion. Interestingly, while Moody’s had previously taken similar actions, the banks they targeted had assets totalling more than US$560 billion. It’s also worth noting that both agencies only agreed on the downgrade of Associated Banc-Corp.
This shift in credit ratings points to a much more significant issue plaguing the banking sector: rising funding costs. Historically, banks have been the benefactors of copious deposit inflows, which came at minimal interest obligations. These deposits have acted as a reliable cushion, supporting lending operations. But the landscape is rapidly changing. Escalating rates on U.S. Treasury bills, among other factors, have made alternative investment avenues like money market funds, which have reached nearly US$6 trillion in assets, increasingly attractive.
Crane Data’s index of the average yield on 100 of the largest money-market funds recently rose to 5.15 per cent, a series high. And according to one observation, while Crane’s data only goes back to 2006, Peter Crane, was quoted as noting, “It’s likely the highest yields since 1999.”
The result? Banks are in fierce competition to retain and attract deposits, with many finding it challenging.
Consequently, with a massive outflow of deposits close to a trillion dollars since April 2022 and only a fraction (approximately 10 per cent) returning banks are searching for alternative funding methods. The surge in borrowing from the Bank Term Funding Program (BTFP) and the rise of brokered deposits are two such strategies. The Federal Home Loan Banks (FHLB) also play a pivotal role. The combination of these strategies helps to balance the scales, but not without increased costs, as seen in the rise of interest rates on these loans.
You might not be hearing much about it right now, but it is worth keeping at least one eye on the situation. Sometimes, these trends become major talking points among investors that then takes on a life of its own. It may turn out to be nothing, much like the so-called ‘Mortgage Cliff’ everyone else was so worried about at the start of the year. But equally, it could become something, so just keep an eye on it.
The current environment of rising interest rates has left banks with significant unrealised losses. By way of example, the 10-year U.S. Treasury note spiked to a staggering 16-year high resulting in a rush for deposit funding and encumbering banks with over US$500 billion in unrealised losses on their holdings of U.S. Treasury and mortgage-backed securities.
The inversion of the yield curve, where short-term borrowing rates supersede long-term lending rates, has also been a challenge, further pressuring the profitability of U.S. banks. Thankfully, a recent reduction in this inversion suggests a more stable future.
U.S. banks are navigating challenging waters. If the U.S. equity market starts to worry, it might sneeze, and of course, we always catch a cold when that happens.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
