☀️☕️ Leaping Loan Losses!

📊 Also: US in “The Last Part”; UK in a Spiral? 🎓️ Interest Rate Trade-off for Banks

Jul 11, 2023

📈 Market Roundup 12-July-2023

US large-cap S&P 500 closed 0.67% UP ▲

Tech-heavy Nasdaq Composite closed 0.55% UP ▲

Pan European STOXX Europe 600 closed 0.72% UP ▲

HK/China's Hang Seng Index closed 0% flat

Japan's broad TOPIX closed 0.28% DOWN 🔻

📝 Focus

Leaping Loan Losses!

📊 In the Markets

US in “The Last Part”
UK in a Spiral?

📖 MoneyFitt Explains

🎓️ Interest Rate Trade-off for Banks

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📝 Focus

Leaping Loan Losses!

Big US banks will kick off the earnings season this week… and are expected to report a huge jump in loan losses as the cost of rising interest rates puts pressure on borrowers. Banks have benefited the last few years from higher lending rates and deposit rates that have risen by less, and also from investment income.

.....▷ Banks have had three years of relatively low defaults, partly helped by pandemic-era stimmy cheques and other government assistance. But they are now starting to experience the inevitable trade-off🎓, with the negative effects of higher rates on borrowers kicking in through bad debts as well as "provisions" against potentially bad loans that the banks made. Credit cards and commercial real estate loans are among the biggest areas of pain for banks. The slowdown in investment banking deal-making and trading revenue is also likely to hit earnings.

.....▷ The six largest US banks, including JPMorgan Chase, Bank of America, Wells Fargo and Citigroup, are estimated to have written off $5bn of defaulted loans in Q2, with an additional $7.6bn in provisions. For now, the positives of sharply higher interest rates seem to outweigh the negatives for most of the big banks.

.....▷ Loan losses are a normal and expected part of lending and of the economic, business and banking cycle. Prudent banks will set aside provisions in the good times (including when loans are made) ahead of the inevitable downturn later in the cycle.

That borrower seemed so good when we made the loan, and never looked like defaulting on us
- Image credit: The 100 / The CW via Tenor

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📊 In the Markets

US in The Last Part: US stocks closed higher as investors awaited consumer price inflation data on Wednesday that will provide some insight into future US interest rate changes. (Prices for the goods and services used to calculate the CPI are collected in 75 urban areas throughout the country and from about 23,000 retail and service establishments. Data on rents are collected from about 50,000 landlords or tenants.) Wall Street’s Finest are expecting a year-on-year inflation rate of 3.1% for June, down from May's 4%, bringing it closer to the target rate of 2%, though “core” CPI, which excludes volatile food and energy prices, is expected to increase 5.1% annually vs May's core CPI of 5.3%. (The Fed prefers PCE inflation data, which is broader and which comes out July 28.)

..... ▷ The relatively dovish Atlanta Federal Reserve president Raphael Bostic on Monday suggested that a return to the 2% target was possible without further rate increases, while San Francisco Fed president Mary Daly said that the Fed was nearing “the last part” of its rate hiking cycle. (Unfortunately, neither are voting members of the FOMC this year.)

UK wages and prices
- Image credit: Tenor

UK in a Spiral?: Europe was mostly stronger, but the UK lagged with the FTSE 100, only up 0.1% after data showed UK wage growth accelerated more than expected in the three months to May, stoking fears of the dreaded wage-price spiral that most other developed economies seem to have avoided (so far.) This is where wage increases push up costs that are passed on in higher prices which then leads to demands for higher wages, which then…

..... ▷Asian stocks were firmer on Tuesday as well, after Chinese officials on Monday said measures designed to support the extremely troubled property sector would be extended until the end of 2024.

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📖 MoneyFitt Explains

🎓️ Interest Rate Trade-off for Banks

There is a trade-off for commercial banks when interest rates go up. The effect can be bad for them because

New loans can fall (higher interest rates mean a higher cost for borrowers)

An economic slowdown can lead to losses from some existing borrowers, with more unable to make either interest payments or repay the principal borrowed. Banks will also usually deduct "provisions" against future loan losses from their revenues.

Fees, including those on investment banking deals (if any), also tend to be lower in a slowing economy.

The positive side, however, is on pricing:

Spreads, the interest rate it lends at (in loans to customers) vs the amount it borrows at (from its depositors), tend to be wider. This increases net interest margins and, therefore, net interest revenue, the difference in dollar terms between how much a bank earns on its loan book and what it pays out for deposits.

When rates go down, banks benefit because more deposits are short-term and go down quickly, compared to loans which take longer to change their rates. But when rates go up, banks can often take their own sweet time to raise deposit rates, so they don't lag the higher loan rates by much, if at all. (Especially large banks with deposit franchises).