Friday, February 27, 2009

Ideology over numbers

Simple observation required here.  Almost every comment on my post about widening interest margins argued that they were only widening because of guaranteed funding by the Federal Government.

It is simply not true.  Look at the numbers and the interest margin was widening sharply until the third quarter of 2008.  Indeed interest revenue was a record every single quarter of last year – and that was the case at most banks.

Bank of America did not get any guarantees until that point.  You can do the maths on the guarantee and they cannot explain the massive surge in the fourth quarter (too little money, too late).  In the Bank of America case most of the guarantees were backstop after they purchased Merrills.   They happened this year and hence outside the fourth quarter.  

Revenue is rising at pretty well every bank I look at.  Doesn’t matter if it is in America or not.  It doesn’t matter whether it got a lot of government assistance or not.

Just accept it – for franchise banks – those that have good access to deposits or other sources of funds – revenue for a bank is rising.

It rises faster if the government will lend you wholesale money at government interest rates.  But it is rising regardless.

This should not surprise people but there is resistance.  In the boom there was no government assistance – and yet interest margins went down and down and down and down.

The banks levered themselves up further and further to get what they deemed acceptable ROEs.  

At the moment the reverse is happening.  Margins are going up and up and banks can’t de-lever themselves fast enough to survive.  


PS.  Just to further rub in the numbers - a liquidity trap means people save cash rather than spend.  That is the macro problem.

So deposit balances are growing sharply.  Bank of America deposits were up from 492 to 583 billion over the past year.  I think that is good news for Bank of America.  The cost of those deposits on average was down sharply.

Further - the non-interest bearing deposits were up by 25 billion.  The bank gets to lend those new deposits at marginal loan rates slightly above their average loan rate of 560bps.  One and a half billion dollars of the rise (annualy) is explained just by those numbers.  The vast increase in the extra low-rate deposits explains a good proportion of the rest.

If you think that bank revenue is rising simply because of the government guarantees then you are letting ideology get in the way of the numbers.  Bank deposits are rising.  The cost of those deposits is falling.  Banks with good franchises are finding that they don't need to chase to get zero rate deposits.

The opportunties in banking are wonderful - provided you can survive to take advantage of them.


Anonymous said...


I posted this below, so apologies.

The question is, what would deposit rates be in the absence of FDIC guarantees and TAF funding?

-slightly higher
-massively higher

I think its reasonable to choose the last one. I'd like to hear your counterargument.

In the comments section below I argue that reacting to deposit rate spiked by raising lending rates only results in a reduced amount of credit and higher provisioning. Examples of this are the banking systems of Argentina and Brazil (in the 90's). Were lending rates to further spike today, in the U.S., the outcome would be highly predictable.

John Hempton said...

In the absence of FDIC guarantees - lower. Sharply.

Proof. The foreign branch deposits of Bank of America - which are not FDIC guaranteed yield 270bps in 2008 versus 463 in 2007.

No guarantee. Rates are falling.

Margins are rising without guarantee.

John Hempton said...

More to the point - there is 100 billion in non FDIC guaranteed foreign deposits.

The rate on those dropped almost 2%.

The yield on loans only dropped basis points.

There is almost 2 billion more revenue there too. No guarantee - just another 2 billion in revenue.

Anonymous said...


I don't understand your example. There is a massive Bernancke-Geithner "put" in place for BofA and Citi - if that put was removed I have to believe uninsured deposits would seek a safer haven.

Bernancke and Geithner have all but announced that they will do whatever it takes to save Citi and BofA. That is a form of insurance. Your example may say more about the perceived (lack of) quality of banks outside the US than anything about the earning power of the US mega-banks.

Personally, I'm starting to warm up to the idea of removing the put and seeing how long BofA and Citi survive. A science experiment as it were. That's bailout fatigue talking - a visceral hatred of bankers and the fear that saving these clowns will drag the US economy down for 10 years or more in massive public sector debt.

I'll have a glass of wine and try to get over it.

Best regards.

John Hempton said...

There was no new Geithner put in June. None at all.

Nobody in June thought Bank of America would fail. People did talk about Citigroup.

But in those days Bank of America had not purchased Merrills and had it not purchased Merrills it was fine.

Interest margins were going up in June too.

Sure they went up further and faster after the government guaranteed money came through.

But margins have been rising ever since the boom ended.


Elwood Anderson said...

You don't address why banks are able to get zero rate deposits. It's because the government is flooding the financial system with free money. Even if a bank didn't get bailout money, they are profiting from the overall bailout deluge, which keeps borrowing rates low. Then their own unwillingness to lend drives the spread way up. It reminds me of the girl from Peru.

There once was a girl from Peru
Who filled up privates with glue
She said with a grin
They pay to get in
Now, they'll pay to get out again, too!

John Hempton said...

No - rates would go to zero without the liquidity flood too.

We would get deflation driven by delveraging. Zero rates are a very good post tax return in a deflation period.

If you assume prices fall 5% annually you are dead keen to hold money.

Dead keen. Zero is the number.

Anonymous said...

Your data demonstrates that it's almost certainly government guarantees that's created the bank windfall.

(i) Fed support of asset backed commercial paper by allowing banks to discount their own issues at the Fed. End of August 2007.

(ii) TAF December 2007. Allowed banks to issue ABCP and discount it with the Fed behind closed doors -- precluding investor reaction. This constituted an unlimited back door credit line -- at least until the Fed decided to pull it. Instead we got FDIC guarantees a year later.

Anonymous said...

Net interest margin has actually been dropping, so while you see a larger total interest income each year, this means a lower return on equity for banks. As the following Bloomberg article via Asia Times implies, many of those past profits came from now-reduced credit lines to now-troubled companies. In other words, these incomes streams won't last much longer. A bit offtopic, but I just don't trust what banks say about their balance sheets/income statements. Its too easy for them to fudge their numbers.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.