After years of contraction, credit card balances at large US banks are starting to rise

The pace of US consumer credit expansion remains brisk. A quick look at consumer loan balances at large US commercial banks shows a spike that started in February of this year.

Note: This data excludes mortgages and government-held student loans

It is useful to look at the breakdown of this growth. As discussed earlier (see post), we know that auto loans have been the darling of large US banks, particularly as mortgage refinancing slowed. The steady growth in auto finance at these institutions continues.

"Other Consumer Loans" are mostly auto loans (nonrevolving credit)
(note: this excludes mortgages and government-held student loans)

But auto loans only partially explain the spike in consumer finance in recent months. The other component of consumer finance on banks' balance sheets is revolving credit, which is mostly credit cards. In late March of this year, credit card debt balances at large US banks have bottomed - after years of declines. With credit card and auto finance now both on the rise, the overall US consumer credit expansion has accelerated.

Revolving credit at large banks - mostly credit cards (note: this excludes home equity debt)

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International banks under pressure

What is wrong with the international banking system? In order to maintain sustainable global economic growth, the banking system needs to be functional and profitable. Bank shareholders should be enjoying declining default rates that result in stable dividends and better capitalization. Instead we get this:

• Bloomberg: - The paper is the first to raise the possibility that the five banks overseeing the century-old rate -- Barclays Plc, Deutsche Bank AG, Bank of Nova Scotia, HSBC Holdings Plc and Societe Generale SA -- may have been actively working together to manipulate the benchmark. It also adds to pressure on the firms to overhaul the way the rate is calculated. Authorities around the world, already investigating the manipulation of benchmarks from interest rates to foreign exchange, are examining the $20 trillion gold market for signs of wrongdoing.

• NY Times: - Barclays said on Tuesday that it would cut as many 12,000 jobs this year, or about 8 percent of its work force, as part of a painful restructuring that began a year ago. The chief executive of the British bank, Antony P. Jenkins, has been trying to overhaul Barclays and revive its image in the eyes of British consumers after a series of scandals in the last few years, including the manipulation of global interest rate benchmarks. Mr. Jenkins took the top job in 2012 after the ouster of Robert E. Diamond Jr.

• Forbes: - Fraudulent dealings by a client tied to Mexico’s oil industry have landed Citigroup's subsidiary in the country in trouble and forced the bank to revise its previously-reported 2013 earnings. According to the bank’s announcement Friday, Mexican subsidiary Banamex extended $585 million of credit to an oil services company in Mexico known as OSA. The financing was for accounts receivable from the country’s state-owned oil business Pemex, which informed Citigroup that the valid receivables were far less than the figure held up by OSA.

• CBS: - Billions of dollars in U.S. taxes are going unpaid because Americans are exploiting Swiss bank accounts, and the U.S. government has failed to aggressively pursue Switzerland's second-largest bank, a Senate investigation has found. The bank, Credit Suisse, has provided accounts in Switzerland for more than 22,000 U.S. clients totaling $10 billion to $12 billion, according to a report issued Tuesday by the Senate Permanent Subcommittee on Investigations. The U.S. government has received only 238 names of U.S. citizens with secret accounts at Credit Suisse, or just 1 percent of the estimated total, the investigation concluded.

• WSJ: - Royal Bank of Scotland Group PLC announced a plan to cut around £5 billion ($8.3 billion) in costs over the next four years as the state-controlled bank posted its second-largest ever full-year net loss. The 81% state-owned lender reported a £9 billion net loss for 2013 on Thursday, compared with a £6.06 billion net loss the year before, hit by soaring impairments and restructuring charges. Revenue sagged 12% to £19.44 billion. Shares slumped 7.9% in afternoon trading.

Some shareholders (which include governments) are afraid to read the news - one just can't tell where the next disastrous bank-related story will appear. This begs the question: are global bank regulators focused on the wrong things? Is the Dodd–Frank implementation - and similar international regulatory efforts - making the banking system any safer? Or are the banks and their management teams distracted with behemoth Volcker Rule and Basel III implementation projects instead of properly running their businesses?

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Banks outperform the market, with regional banks pulling ahead

The US banking sector continues to outperform the broader market. Furthermore, for the first time this year, regional bank shares are outperforming the overall bank index, which is driven primarily by the largest banks.

Red = S&P500; Green = S&P total banking sector index ETF; Blue = S&P regional banks index ETF

The key reason for the strong performance among US banks remains the steepening treasury curve. Banks pay next to nothing on deposits while charging a rate that is often linked to treasuries on the loans they make. The steeper the curve, the wider the "margin". And given the leverage inherent in the banking system, even a small margin increase materially improves the return on equity.

The treasury curve has been steepening sharply in recent weeks - as seen from the spread between the 10y and the 2y yields (as well as 30y and 2y).

What's driving this steepening? Historically, rising longer dated bond yields were caused by higher inflation expectations. That's not the case this time around. In fact as the chart below shows, longer-term inflation expectations have been declining.

Dow Jones Credit Suisse 10-Year Inflation Breakeven Index

The rise in yields is instead mostly driven by higher expectations of earlier and faster reductions in securities purchases by the Fed. In particular, some at the Fed have been happy to see a bit of stabilization in monthly payrolls growth (at around 200K).

The sustainability of this trend is yet to be proven, but combined with better GDP figures (see chart) and improved new home sales (see chart), these data may be sufficient to push even this dovish FOMC into launching its exit sooner than expected. The fact that corporate spreads are at the levels not seen since 2007 (see post) doesn't help the case for maintaining the current pace of QE either.

At the same time, Bernanke was quite clear that it will be some time before the Fed will begin pushing up short-term rates - even after QE ends. We therefore have the short-term rates (and therefore bank deposit rates) remaining near zero, while longer term rates rising due to expectations of taper. This is resulting in significant curve steepening, a great environment for banks.

The next question is why all of a sudden we are seeing regional banks outperforming the overall banking sector. The answer has to do with the changing regulatory landscape, as the Volcker Rule is about to go into effect.

WSJ: - Barring a last-minute surprise, the votes will result in tighter restrictions on certain trading activities that go beyond what regulators had agreed to just a few weeks ago, according to people familiar with the matter. Since then, regulators have been locked in tense negotiations that threatened to upend the provision.

Under the final rule, regulators are expected to closely track trading activities with an eye on whether certain trades known as hedges are designed to post a profit rather than offset risks that accompany trading with clients. The finished version of the Volcker rule is likely to require that hedges be designed to reduce specific risks, according to a portion of the proposed rule reviewed by The Wall Street Journal.

Hedging activity should shrink or alleviate "one or more specific, identifiable risks" such as market risk, currency or foreign-exchange risk, and interest-rate risk, the language says.

"This is the new era of Big Brother banking," said Michael Mayo, an analyst with CLSA Americas. "Now banks' fortunes are more closely tied to the government."

This "Big Brother banking" will have a far greater effect on the largest financial institutions than on the regional or smaller banks. The inability to trade in "prop" accounts is already resulting in reduced liquidity and weaker market making capability among the larger banks. As a result, in the US bond markets for example, banks often do little more than act as "introduction brokers" for a quarter-point spread. In some instances this is far cry from the high volume market-making activities banks used to be involved in. All this is resulting in declining "sales & trading" revenue for the largest banks.

Bloomberg: - The $44 billion at stake represents principal trading revenue at the five largest Wall Street firms in the 12 months ended Sept. 30, led by New York-based JPMorgan, the biggest U.S. lender, with $11.4 billion. An additional $14 billion of the banks’ investment revenue could be reduced by the rule’s limits on stakes in hedge funds and private-equity deals. Collectively, the sum represents 18 percent of the companies’ revenue.

Not facing these same headwinds, regional banks are now outperforming.

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Local banks still weighed down by commercial real estate

While the media and politicians have been focused on large commercial banks and their activities, it is often the smaller US banks that continue to struggle with capitalization and stressed/distressed assets. A big part of the issue with small banks is their outsized exposure to commercial real estate. At its peak, nearly 30% of small banks' balance sheets consisted of loans backed by commercial property. Large banks peaked at 11%.

Source: FRB

Large banks have since reduced (as % of assets) their commercial real estate exposure by 35% (from the peak), while small banks have cut it by 24%. As far as their non-performing real estate-backed loans, the bigger banks have largely cleaned up that portion of their balance sheets while many regional and smaller banks have kicked the can down the road. And numerous loans that were restructured in 2011 and 2012 are once again delinquent. The chart below shows the evolution of troubled loans at small and regional banks.

Small and regional banks' real estate backed assets ($bn)

Compared to the money center banks, regional and local banks have a long way to go to resolve their commercial real estate problem.

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From our sponsor:

Small business loan approval rates - latest trends

The latest statistics on small business lending show application approval rates rising at banks. It seems however that banks are still relying on taxpayer support to provide credit.

Biz2Credit: - "Smaller banks are making more and more loans through the SBA's Small Loan Advantage Program, which range in amounts from $50,000 to $350,000 and require little collateral," said Biz2Credit CEO Rohit Arora, who oversaw the research. "Big banks, including Sovereign and Citizens Bank, are also increasing their approvals of loans between $50,000 and $500,000. We have even seen an uptick by giants such as TD Bank and Bank of America. Small business lending is a profitable business.

Source: Biz2Credit

Credit Unions on the other hand are declining more applications than in the past as they lose ground to banks. Shadow banking ("Alternative Lenders") still has the highest loan application approval rates. These lenders include "accounts receivable financers, merchant cash advance lenders, Community Development Financial Institutions (CDFI), micro lenders, and others".

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From our sponsor:

Apparently the Bank Transfer Day was about moving cash TO large banks

Remember this?

AmpedStatus: Together we can ensure that corrupt crony-capitalist banking institutions will ALWAYS remember the 5th of November! If the 99% removes our funds from major banking institutions to non-profit credit unions on or by this date, we will send a clear message to the 1% that conscious consumers won’t support companies with unethical business practices.

And how about this?

Credit Union National Association: At least 650,000 consumers across the nation have joined credit unions in the past four weeks, reflecting consumers' reactions to rising fees at banks, according to a survey by the Credit Union National Association (CUNA).

They have joined credit unions since Sept. 29, when Bank of America (BofA) unveiled its plans to charge $5 a month for debit cards. The public outcry the past month has forced BofA and other big banks to reconsider their debit fees.

CUNA estimates that credit unions have added $4.5 billion in new savings accounts. More than four in every five credit unions experiencing growth since Sept. 29 attributed the growth to consumer reaction to new fees imposed by banks, or a combination of consumer reactions to the new bank fees plus the social media-inspired Bank Transfer Day. Bank Transfer Day, which is tomorrow, urges consumers to switch from big banks to smaller credit unions and community banks.

Now the question is, did it work? Were the large US banks taught a lesson they will never forget? Did droves of depositors move their cash to smaller institutions? The answer may surprise and upset some people. Despite the protests and the grass roots movement to shift deposits to credit unions and local banks, the large US banks increased deposits at over twice the rate of small banks (including credit unions).

Relative growth in deposits (12/29/2010 = 1.00; source: the Fed) 

Overall deposits at US chartered institutions increased materially in 2011. Fears surrounding the situation in the Eurozone forced corporations and individuals out of risky assets and prime money market funds. Those withdrawals were flowing into treasuries and bank deposits. Large US banks increased deposits from the end of 2010 by over 15% (about net $0.65 trillion on an absolute basis). By contrast smaller institutions grew deposits by less than 7% (about net $0.17 trillion on an absolute basis).

Large US banks benefited from redemptions out of prime (excluding treasury and muni) money market funds, who had material exposure to Eurozone banks via dollar commercial paper. The overall assets dropped by 12% (absolute level was net down $0.19 trillion.)

US prime money market funds total assets ($mm; source: ICI)

New cash for large US banks in 2011 also came at the expense of foreign banks (such as ING). The drop was almost 18%, with net withdrawals of $0.19 trillion. The only reason this decline wasn't larger had to do with the fact that Canadian banks did relatively well.

Deposits of foreign banks in the US ($mm; source: the Fed)

Clearly a large portion of these deposits came from corporations instead of individuals. Nevertheless the "dump your large bank" motto just didn't work. Maybe "dump your foreign bank" or "dump your money market fund" would have turned out to be more effective. Apparently talk is cheap and when push came to shove, the bulk of US depositors simply felt safer moving their cash into large US banks.

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Would you deposit your money at JPMorgan Chase or Credit Lyonnais?

The equity markets sold off after the close, with Morgan Stanley down 0.8% after hours and 3.5% correction intraday.  At least a portion of this move was driven by the S&P "refreshing" their rating methodology for financial institutions:

Reuters: Standard and Poor's reduced its credit ratings on several big banks in the United States and Europe on Tuesday as the result of an overhaul of its ratings criteria. 

A few surprising results:  Most US  and UK institutions got their ratings reduced by one notch, while ratings for firms like Deutsche Bank, Societe Generale, Credit Agricole, BNP Paribas, and Credit Lyonnais were left unchanged.  What changes in the methodology would explain this?

There are two factors impacting these new ratings in addition to the traditional "bank-specific factors" (see chart below):

1. Macro:  the rating agency is focused on how strong the banking business is in that country. Is the economy reasonably strong, how creditworthy is the sovereign where the bank operates, how good is the regulatory framework, how strong is the private sector, etc.

2. External support: how much is the government of that nation willing to do what the Fed and the US Treasury did with the banking system in the US in 08/09? 

So according to the S&P, because France and Germany are rated higher than the US based on the combination of the above criteria, there is a downward adjustment to the US firms.   The US sovereign rating is lower, the economy is slow, the regulatory framework is getting worse, and the government is no longer willing to support the financial system in a crisis (in a way that say Germany, France, or for that matter Japan or China are willing to do).  

This all makes sense, but should Credit Agricole, Credit Lyonnais, and Deutsche Bank really be A+, while JPMorgan Chase be A?  With the eurozone crisis raging,  here is a simple question - would you deposit your money at JPMorgan or Credit Agricole?


Source: Standard & Poor's

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Keep your money "local"

A recent article in the NYTimes had put a nice spin on the numerous failures of community banks:

NYTimes: “People are angry with all the shenanigans on Wall Street,” [Camden R. Fine] said. “They believe their money stays local when they put it in a community bank, rather than sent off to Never-Never land.”

Yes, the money stays local alright. In fact there are numerous cases of real estate developers (you know, the local ones) getting on the boards of local banks to "advise" these banks to lend to them. Some even formed their own banks. Yes, why not use those local deposits to get rich on local construction projects with just a bit of help from the national taxpayer via the FDIC.

The chart below shows where that "local" money went. This is a comparison of commercial real estate loans as percentage of banks' assets for community banks vs. the large banks. It includes construction loans for those local strip malls, office space, single family housing developments, and those great condos. Many of those are nice and vacant now and the "local" developers are not local any more - they closed shop and skipped town.


source: FRB

These credit driven construction projects had created millions of jobs financed by those local FDIC secured deposits. But they were "bubble jobs" that were not sustainable and are not coming back any time soon. And people wonder why US employment continues to struggle.

Of course Mr. Fine does a good job blaming the large banks - after all it's an easy target. The taxpayer should in fact be angry with the regional banks who have put the FDIC in the red.

So next time you plan to open that account at Chase, hold off, think about it. Maybe you should keep your money local too, so it doesn't end up in the Never-Never land.

The gap in the US banking system

We recently received a comment related to bank failures from someone pointing out that in Germany, with a population of some 82 million, there are only about 5 banks (there are actually more - but let's stay with this line of thinking). The question was why does the US need that many banks?

For one thing, banks in the US used to be quite profitable in the real estate boom days. They were also relatively easy to set up (particularly relative to Europe). The 2008 crisis however may have taken care of that, pushing the US closer to the German banking system, dominated by large national banks. The chart below shows the 2001 US banks sorted by total assets. It's a fairly continuous chart that may resemble other sectors with a relatively open competition.



But the crisis changed all that. The 2009 picture looks quite different, showing a large gap between the fourth (Wells) and the fifth (PNC) largest bank (when comparing total assets). The ratio of assets between these two is over 4.5, showing that the top four banks are massively ahead of the rest of the industry.



Large banks have tremendous advantages - from regulatory support to cheaper cost of funds and less reliance on deposits (ability to borrow interbank or in the capital markets). That advantage will continue propelling the larger banks ahead of the rest.

The gap some may argue is filled by institutions that have just become bank holding companies, such as Goldman and Morgan Stanley or non-banking firms such as MetLife and Amex (both of which have a bank holding status). But these firms don't significantly impact the consumer landscape, where the big three banks are beginning to completely dominate (it's unclear if the investment banks have any plans to get into retail banking). The chart below from the Washington Post illustrates the deposit growth at large banks (mostly driven by government arranged acquisitions, but also attracting nervous depositors leaving smaller banks.)



And here is a comparison to the deposits various institutions controlled in 2007 (from the Washington Post):



Unlike Germany, where regulators are quite happy with the large few (Landesbanks, Commerzbank, Deutsche Bank, DZ Bank, etc.) dominate the landscape, the US regulators are quite nervous. From the Washington Post:

Regulators' concerns are twofold: that consumers will wind up with fewer choices for services and that big banks will assume they always have the government's backing if things go wrong. That presumed guarantee means large companies could return to the risky behavior that led to the crisis if they figure federal officials will clean up their mess.

One solution the regulators are proposing is to increase capital requirement on the larger banks.

That [Obama administration's proposed] plan would impose higher capital standards on large institutions and empower the government to take over a wide range of troubled financial firms to wind down their businesses in an orderly way.

But capital increases will negatively impact lending, as banks would rather focus on fee businesses that require little balance sheet usage. Reduced lending is the last thing this economy needs. But that seems to be the direction large banks are taking as they continue to probe for weaknesses in the wall of regulatory rules to come up with solutions that require less capital (whether it's rating agency shopping or TRS).

On the retail side however, foreign institutions are starting to make inroads, trying to fill the gap. From HSBC to ING, foreign banks are trying to grab share of US deposits. Some are trying to get in by acquiring failed US banks. From the WSJ:

The sale of the operations of failed Guaranty Bank in Texas on Friday to the U.S. division of a Spanish bank signals that foreign banks can succeed in the auctions for collapsed U.S. lenders.

Banco Bilbao Vizcaya Argentaria SA on Friday became the first foreign company to buy a failed U.S. bank in this crisis; on Friday, federal regulators shut down Guaranty.

Other foreign banks with a U.S. presence interested in gobbling up failing U.S. banks include French bank BNP Paribas SA through its San Francisco subsidiary, Bank of the West; Toronto-Dominion Bank, through its Portland, Maine, subsidiary, TD Bank; and Rabobank, the El Centro, Calif., subsidiary of Rabobank Group of Utrecht, Netherlands.

With competition still in place in the US (for now), it's unlikely the US banking system will converge to look exactly like the one in Germany going forward (it's much harder for a new bank to make inroads in Germany). However the landscape, shocked by the financial crisis, will be changing rapidly, becoming almost unrecognizable in years to come.

Small bank, big bank - the difference is real estate exposure

As a follow-up to our previous post, on failures of small banks, here is an interesting fact: small banks had significantly higher exposure to real estate than large banks.

There is a general misconception out there that the large banking institutions have been responsible this financial crisis by taking excessive risks, while the "main street" banks have been relatively prudent. This assumption turns out to be completely wrong.

Using data from the Fed, we looked at the ratio of real estate loans to total assets for large and small domestically chartered US banks (for reference: FRB data code H8/H8/B1026NLGAM over H8/H8/B1151NLGAM). For large banks we also included mortgage-backed securities (code H8/H8/B1303NLGAM). The result is actually quite shocking:


Source: Federal Reserve Board

At the peak, almost 50% of small banks' balance sheets was in real estate loans. Large banks never got close to those levels. Furthermore small banks' real estate related portfolios have not decreased significantly - still over 45%. It's no surprise therefore that small banks are not lending and Meredith Whitney is predicting 300 additional small bank failures.

Small banks used depositors' money and the taxpayer's guarantee to lend against real estate without much consideration for diversification. This is indeed bad news for the FDIC and the taxpayer. What's ironic about this situation is that TARP funds will likely be repaid - it is even entirely possible that the Treasury will end up making money on TARP (with dividends and warrants). However the bulk of taxpayers' money to bail out the FDIC deposit insurance fund (FDIC is asking Congress for a half a trillion credit line) will probably never be recovered.