QABA - The Fed's Banking Report Sheds Light On The Sector

2023-03-27 07:40:19 ET

Summary

• Last Friday, the Fed released a detailed report showing cumulative balance sheet data from banks as of March 15th.
• Many have focused on the increase in borrowings by banks.
• Upon closer review and financial ratio calculation, there are other data points that are jumping out to watch.

Since the failure of SVB, a massive amount of attention has been drawn to the banking sector. Last Friday, the Federal Reserve released detailed data regarding the state of the banking system through the week ending March 15th. The H8 report was the most detailed report since regional banks came under stress following the SVB fallout. While the level of borrowing has been the most publicized statistic, there are some metrics that are reassuring and a few worth additional monitoring.

The most popular data point that has been making its rounds around the Internet is the level of borrowing banks have undertaken. According to Friday's report, banks increased their borrowings by over $400 billion to $2.4 trillion. This was the highest total level of borrowing since the 2008 financial crisis and it is expected to go higher when the next report is released this Friday.

Before panicking, investors need to dive deeper into the banking system's ability to repay those loans. In doing so, they would find that this level of borrowing is more than sufficient. First, banks are using treasury and mortgage backed securities as collateral against these borrowings. As of March 15th, the level of borrowing as a percentage of these securities is 44%. While this level is up notably in this business cycle, it is below the levels of over 50% from before the pandemic.

In addition to securities, banks have plenty of cash on hand. For every dollar of cash on hand, the banking system has borrowed 70 cents, which is 20 to 40 cents higher than pre-pandemic levels. The banking system is well insulated from a liquidity standpoint.

The Fed indicated in last week's meeting that a credit slowdown is likely to occur as a result of the unrealized losses on bank balance sheets and the stress within the regional banking sector. Currently, loan growth year over year remains robust. In fact, year over year loan growth recently outpaced the loan growth experienced during the PPP era. However, it is important to note that major growth in loans occurred just prior to the recessions in 2001 and 2008.

Leverage (total liabilities divided by total equity) is another area worth monitoring in the banking sector. Prior to the pandemic, bank leverage ratios hovered around 8 to 1. Once the economic stimulus hit, they jumped to around 10 to 1 and are currently sitting at just under 9.6 to 1. If borrowing grows astronomically and leverages rises in tandem, it will signal that capital is exiting the banking system. For now, the situation is manageable.

One area of the banking sector that is showing unprecedented volatility is the total number of deposits. The most recent accounting for deposits shows that the total is 3% lower than a year ago, and while some may consider that a modest decline, it is actually the biggest drop in the 50 years that the Federal Reserve has been tracking the data. The large move downward was preceded by a period of the largest gains in deposit activity, thanks to over accommodating monetary policy.

Declines in total deposits are uncharted waters for the banking sector and will require careful attention as the strain on regional banks plays out. Next month, first quarter earnings reports on our banks will begin to shine light on how much damage a bank has taken on its balance sheet. Until then, we can continue to monitor weekly reports from the Fed for any other big changes.

In the meantime, investors can take advantage of the discounted share pricing in ETFs, which have a wider exposure to the sector and are more insulated from singular bank failures.

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