The new year is nearly upon us, and one idea for where to invest is the banking sector, whose margins benefit from the high interest rates, at not terribly demanding valuations.
Here to counter that view is Christopher Whalen, the chairman of Whalen Global Advisers, who makes the bold case that banks were short over $1 trillion in capital at the end of the second quarter, and that it’s only going to get worse as the Fed keeps hiking interest rates.
That claim may surprise those who think the U.S. banking industry has some $2.2 trillion in capital. But he whittles that figure in several ways. First, he notes, there’s a difference between book equity and tangible equity, the latter of which is used by banking regulators to evaluate solvency. It’s a narrower definition, excluding items like goodwill and deferred tax assets, that brings the total down to $1.49 trillion from $2.22 trillion.
Then, drawing on Federal Deposit Insurance Corp. data, he subtracts what’s called accumulated other comprehensive income. “Thanks to QE and now QT, all sorts of assets have become negative return propositions for banks and nonbanks alike. If the coupon pays less than the funding costs, you’re losing money,” he says. That takes capital down to $1.23 trillion.
Now comes the more controversial part. First he marks to market losses on loans and securities created during 2020 and 2021, for the impact of this year’s Fed rate hikes. That right there is enough to push banks into insolvency, with some $1.74 trillion of losses from marking to market.
Another $794 billion losses comes if bank holdings of U.S. Treasury securities, mortgage-backed securities and state and municipal securities also are marked to market. Put it all together, on Whalen’s calculations, and banks have a $1.3 trillion shortfall as of the second quarter.
Granted, and this is very important, banks don’t have to mark their assets to market. So what’s the worry? That exception isn’t infinite — banks are allowed to ignore mark-to-market losses so long as they have the capacity and intent to do so. “Even if the bank holds these low-coupon assets created during 2020-2021 in portfolio to maturity, cash flow losses and poor returns could eventually force a sale,” Whalen says.
He performed a similar analysis on JPMorgan Chase
which he calls one of the better managed banks. Jamie Dimon’s bunch has a $16 billion shortfall as of the second quarter — and a $58 billion deficit if the mark-to-market adjustment is a steeper 17.5% — on Whalen’s numbers.
The bigger question is when those asset sales could possibly occur. “Sales of assets will occur slowly but lenders may force issue on collateral that is 20pts underwater,” he told MarketWatch in an email. And what’s unsustainable now is set to get worse. “Higher rates just make eventual mess bigger,” Whalen added.
U.S. stock futures
were pointing higher in early action. Commodities were moving up, with gains for both oil
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Fed Chair Jerome Powell is scheduled to speak at 1:30 p.m. at the Brookings Institution, the current employer of former Fed Chair Ben Bernanke. There are two other Fed speakers as well, with Gov. Michelle Bowman due to speak about banks, as Gov. Lisa Cook speaks at the Detroit Economic Club.
It’s a big day on the economics calendar even excluding the Powell speech. The ADP employment report, the second estimate of third-quarter GDP, the advanced report on trade for October, Chicago PMI, job openings and pending home sales all are due for release, with the Beige Book of economic anecdotes due at 2 p.m.
In the eurozone, year-over-year inflation slowed to 10% in November from 10.6%.
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