KBRA Analytics releases this month’s edition of The Bank Treasury Newsletter, the Bank Treasury Chart Deck, and Bank Talk: The After-Show.

This month’s newsletter discusses the Federal Reserve’s upcoming decision to raise the Fed Funds target rate in September. It then traces the history of monetary policy from the time when Paul Volcker was chairman of the Fed and argues why his prescriptions for inflation in the late 1970s and early 1980s would not make much sense today, given the current structure of the economy and the financial system where nonbank competitors dominate huge swaths of the capital markets. Mr. Volcker’s muscular approach to curing the economy of inflation is then tied, first to the crisis in the S&L industry and later banking crises over the next decade, and also to the birth of the money market fund industry as a direct competitor for bank deposits. After also showing why his actions then can be indirectly tied to the expansion of mark-to-market accounting for the investment portfolio, the newsletter discusses the recent plunge in accumulated other comprehensive income (AOCI) to a negative loss of $236 billion and what this might mean for the future health of the financial industry. And briefly going through 90-plus years of history, the newsletter notes how regulators and accounting standard setters have gone back and forth on the usefulness of mark-to-market accounting in financial reporting.

The newsletter also examines how accounting rules such as Statement of Financial Accounting (SFAS) No. 115 and current expected credit loss (CECL), despite best intentions to address lessons learned after the financial crises of the 1980s and the global financial crisis, which was foremost about improving transparency, ultimately produced the exact opposite outcomes. SFAS 115 was intended to expand the portion of investment securities carried at fair value, but instead led to bank treasurers increasing the securities they were willing to lock up in held-to-maturity to avoid a negative adjustment. And CECL, which was supposed to improve accounting for credit losses, has instead confused investors. Finally, the newsletter discusses how bank treasurers have not seen much change in flows, mixes, or balances of deposits since the Fed raised rates year-to-date, but expect deposit betas to move up in the not-too-distant future. Some are preparing to pay up for deposits to cover recent loan growth.

The Bank Treasury Chart Deck begins with a review of the progress the Fed has made two months into Quantitative Tightening (QT), to shrink its bond portfolio. It then looks at the New York Fed’s latest household survey, which found that consumer expectations have shifted negative, and points out how the inversion of the Treasury 2s-10s yield curve is the sixth time it has inverted since the 1980s. Shifting from there to bank balance sheets, the deck notes how bank balance sheets are remarkably liquid to weather a liquidity storm come what may, presenting as evidence, the 7- ratio of non-maturity deposits that cover securities and loans with maturities longer than three years, as well as other data from the Fed and the FDIC that show how much core deposits now dominate the mix of deposits in the system. In the last set of slides, the deck covers how the industry expanded the security portfolio by over $1 trillion in the last two years, right in time for the Fed’s rate hikes which led to an historic increase in negative AOCI that impacted book equity, despite a near doubling of securities it booked in held-to-maturity, thanks to a sharp increase in bond market volatility in the last year.

On Bank Talk: The After-Show, Ethan explains to Van why bank managers have an economic incentive to optimize the mix of their deposits and reduce unprofitable business, reviewing with him how earnings dilution and regulatory capital charges come into play. Ethan argues that the cost of excess deposits from a shareholder’s perspective goes beyond just the earnings dilution and the increased capital required to carry them on bank balance sheets. It also entails interest rate risk as banks added $1.2 trillion in Treasury and Agency MBS since August 2020. The consequence of their investment timing was a sharp plunge in the ratio of AOCI to Tier 1 capital. Even though other than the very largest banks do not have to count AOCI in the calculation of their regulatory capital, a large minority of regional and community banks reported negative AOCI over 25% at the end of June 30, 2022. Van asked Ethan for ways that analysts could observe how banks are optimizing their deposits. After reviewing the available public data in call reports, and how, according to the FDIC, 80% of deposits are core (versus 50% in 2010), Ethan and Van looked at disclosures that the largest banks report for the liquidity coverage ratio for insights about deposit trends heading toward a larger funding concentration in retail deposits.

Click below to view the reports:

• The Bank Treasury Newsletter Chart Deck: August 2022
• Bank Talk: The After-Show: August 2022
• The Bank Treasury Newsletter: August 2022

About KBRA Analytics

KBRA Analytics, LLC (KBRA Analytics) is our premier product platform for high quality data and advanced analytics. Our seasoned teams of industry specialists across each product provide unparalleled insight creating a foundation of deeper analysis and rapid discovery for users. KBRA Analytics is an affiliate of Kroll Bond Rating Agency, LLC (KBRA). KBRA is a full-service credit rating agency registered in the U.S., designated to provide structured finance ratings in Canada, and with credit rating affiliates registered in the EU and UK.

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