As part of our ongoing series of articles on bank stability, and at the request of many of our clients at Saferbankingresearch.com, we wanted to address the recent Moody's pronouncement.
But before we begin, I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you: the substance of that analysis is not looking too good for the future of the larger banks in the United States. You can read about them here.
Moreover, if you believe that the banking issues have been addressed, I'm sorry to inform you that you likely only saw the tip of the iceberg. We were able to identify the exact reasons in our public article which caused SVB (OTCPK:SIVBQ) to fail well before anyone even considered these issues. And I can assure you that they have not been resolved. It's now only a matter of time.
So, let's look at Moody's recently published update on the U.S. banking sector. The credit agency downgraded 10 banks and also turned negative on several other banks. The update highlighted several larger banks, including U.S. Bancorp (USB) and Capital One Financial Corporation (COF).
According to Moody's:
"U.S. banks continue to contend with interest rate and asset-liability management risks with implications for liquidity and capital as the wind-down of unconventional monetary policy drains systemwide deposits and higher interest rates depress the value of fixed-rate assets."
If you read our previous articles on large banks and the U.S. banking system, none of this should come as a surprise to you. You will probably notice that this Moody's report came out with a significant time lag relative to our analysis, as we have been discussing the issues to which Moody's is referring for the past 18 months.
In fact, as one of my money manager clients noted:
"A colleague said "no one saw this issue with the banks." I just laughed and said that 'Avi from EWT was all over it.'"
In December, we published an article on Capital One outlining the bank's risks, which we explained are major problems for the lender. In particular, we mentioned the following issues: 1) Rising exposure to subprime borrowers; 2) Weak credit quality of the lender's auto business; 3) A high share of problem loans in the bank's CRE book; 4) Ongoing repricing of deposits that will lead to a spike in funding costs; and 5) Maturity mismatch risks due to long-duration bonds.
In January, we published an article on U.S. Bancorp. Despite many viewing the bank as "safe," we outlined quite a lot of issues, including: 1) Large exposure to commercial and CRE lending; 2) A high sensitivity of non-interest income to economic conditions; 3) Maturity mismatch risks due to a longer-duration securities book; 4) Weak operating efficiency; and 5) Low capital adequacy ratios.
Moody's has started to discuss these issues only now, although the banks' 10-Qs and 10-Ks have been showing those risks for more than two years. More importantly, Moody's did not even mention the major issues that were revealed by the 1H23 numbers. So, let's review them now.
First, there is a sustainable trend of asset quality deterioration in consumer loans, particularly in credit cards and car loans. If we look at the latest results of Capital One or Discover Financial Services (DFS), we'll see that charge-off ratios and delinquency ratios are already above pre-pandemic levels. This is especially concerning given that the pre-pandemic operating environment for banks was completely different from what we have now.
The average rate on credit cards was 16% in 2022, and it is more than 22% as of June 2023. Despite the 22% rate, there is still a large demand for credit cards. We believe that the pandemic-related savings are fading, but consumers want to continue spending more than they are earning. Despite significant risks, banks continue to approve those 22%-rate credit cards, as they need to somehow supplement their margins on the back of rising funding costs.
Second, as various indicators show, there are major issues in the CRE lending space. While Moody's mentioned this point, the agency did not discuss the different trends in this sector. Offices are the area of the biggest risk, especially in San Francisco, Los Angeles, and Chicago. Yet, CRE loans that were granted to small businesses that have served their local client base for many years are performing quite well.
Finally, there is a high probability that we'll see a wave of defaults in the large corporate space due to higher interest rates. Obviously, the banks with high exposure to C&I loans are very likely to be hit hard.
Each of these risks is worth a separate article, and we are going to discuss them in more detail in our upcoming articles.
Rating agencies and research departments of large banks are always the last to know. In our view, depositors should not rely on their ratings when choosing a bank for their savings, as their rating actions and comments come out with a significant time lag, and it may be too late for depositors. Remember how well they warned you about the 2008 banking crisis?
At the end of the day, we're speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money.
You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And, if you're relying on the FDIC, I suggest you read our prior articles which outline why such reliance will not be as prudent as you may believe in the coming years.
It's time for you to do a deep dive on the banks that house your hard-earned money in order to determine whether your bank is truly solid or not. Our due diligence methodology is here.