Friday, May 29, 2009
the limitations of fat spreads
To rewind the tape, a major contributor to our current banking crisis is exactly what TV pundits are now encouraging banks to repeat - what's known in the industry as "the carry trade." ... And what did we and the banking regulators all learn from this? Liquidity matters. And now more than ever.
So at a time when banks would really like to reload the carry trade in size, bank regulators are demanding more and more bank-investment holdings to be in cash or cash equivalents - the absolute other end of the yield curve.
Worse, the regulators are trying to wean banks ... off the FDIC-insured debt-issuance program, demanding -- as a precondition to TARP repayment -- that banks demonstrate that they can issue large volumes of long-term uninsured debt. (And in this regard, I'd highlight Goldman Sachs' (GS) $1.0 billion reopening of its 10-year bond at 337.5 bps over the 10-year - or 7.50%. To these eyes, this is arguably a far worse reverse carry trade; borrow long at high spreads and do what with it profitably without taking either extreme credit or market risk?)
Finally, with bank transaction deposits yielding nothing, the average consumer is moving into CDs, trying to take advantage of that same yield curve that the pundits are suggesting banks exploit going the other direction.
The net of all of this is that there are any number of countervailing forces at work, making it all but impossible for banks to capture the opportunity at hand. And as yesterday's FDIC Quarterly Banking Profile highlights, even with all of the government's help to date driving the short end of the curve to zero, bank net-interest margins aren't expanding.
And in the case of smaller banks, they're continuing to shrink.
and from the march 2009 QBP:
For the sixth consecutive quarter, falling interest rates caused declines in both average funding costs and average asset yields. The industry’s average funding cost fell by more than its average asset yield in the quarter, and the quarterly net interest margin (NIM) improved from fourth quarter 2008 and first quarter 2008 levels. The average NIM in the first quarter was 3.39 percent, compared to 3.34 percent in the fourth quarter of 2008 and 3.33 percent in the first quarter of 2008. This is the highest level for the industry NIM since the second quarter of 2006.
However, most of the improvement was concentrated among larger institutions; more than half of all institutions (55.4 percent) reported lower NIMs compared to a year earlier, and almost two thirds (66.0 percent) had lower NIMs than in the fourth quarter of 2008. The average NIM at institutions with less than $1 billion in assets fell from 3.66 percent in the fourth quarter to 3.56 percent, a 21-year low.
that is stunning clarity, and contrary to just about everything one is led to believe about steep yield curves promoting bank recapitalization and economic recovery. one can more easily see now why banks are salivating over the the chance to gobble up heavily discounted securitized assets -- they need to improve their earnings profile in order to recapitalize, and net interest margin isn't doing the trick in spite of a massively steep yield curve!
more nuggets -- the banking system is delevering...
Total assets declined by $301.7 billion (2.2 percent) during the quarter, as a few large banks reduced their loan portfolios and trading accounts. This is the largest percentage decline in industry assets in a single quarter in the 25 years for which quarterly data are available. Eight large institutions accounted for the entire decline in industry assets; most insured institutions (67.3 percent) reported increased assets during the quarter, although only 47 percent had increases in their loan balances. The decline in industry assets consisted primarily of a $159.6-billion (2.1-percent) reduction in loans and leases, a $144.5-billion (14.9-percent) decline in assets in trading accounts, and a $91.7-billion (12.7-percent) drop in Fed funds sold and securities purchased under resale agreements.
... and being weaned off wholesale funding in spite of incipient deflation evident in deposits...
The decline in industry assets and the increase in equity capital meant a reduced need for funding during the quarter. Total deposits declined by $81.3 billion (0.9 percent), while nondeposit liabilities fell by $320.2 billion (9.1 percent). Deposits in domestic offices increased modestly ($41.9 billion, or 0.6 percent), with time deposits falling by $72.5 billion (2.6 percent). Deposits in foreign offices declined by $123.2 billion (8.0 percent). Liabilities in trading accounts fell by $116.8 billion (24.6 percent), while Federal Home Loan Bank advances declined for a second consecutive quarter, falling by $91.0 billion (11.6 percent). Deposits funded 66.1 percent of total industry assets at the end of the quarter, up from 65.3 percent at the end of 2008. This is the highest deposit funding share since March 2002.
... though the fact that one-third of all american banking assets are not funded by deposits puts into perspective what a tremendous delevering still lays before us as the united states narrows its current account deficit.
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