We are glad to see you again. Today, banks and bonds. They are both closely linked. The Fed’s bond buying may have had an even greater impact on banks than any other industry. It remains to be determined if this is a good thing or not.
Bank of America purchases a lot of mortgage bonds, but JPMorgan doesn’t
John Cage, the composer said that boring is the best way to generate ideas. These ideas fly in one’s heads like birds. In my situation, I feel like they are creeping into your head. But Cage’s principle holds true. Writing about finance is boring. Here are the numbers I used from Bank of America’s Balance Sheet for the last 6 quarters. These are the results:
The story of US finance and banking over the last year and a quarter is a fascinating one. Demand is hit by the pandemic, which causes the loan books to shrink. New deposits of almost half a trillion dollars are made, resulting in an increase in the money supply and higher savings rates. As deposit costs drop and rates fall, loan yields also fall. Loan yields are falling faster as borrowers face increased competition and the deposit cost threshold is near zero. Cash yields, mainly deposits at Fed, also shrink.
It’s not a good time to work as a banker. It wasn’t until the spring of 2018, when rates rose, hinting that better times were ahead. What is Bank of America’s response to these changes? Bank of America has more liquidity than needed, and so it purchases a lot of debt securities. It bought $470bn worth of these bonds over the last 12 months. This brings its total to close to $1tn. The average maturity of the portfolio is about four years according to the B of A. These federally-backed mortgage bonds are worth just over $700m.
This is a large number of bonds. In the last year, $480 billion worth of mortgage-backed securities was purchased by the Fed as part of QE. With $360bn, B ofA is not far behind. In fact, QE also helped B ofA acquire mortgage-backed securities worth $480bn.
It isn’t surprising that B of A buys. It is simply trying to make more income. It is worth it to have the additional money in securities instead of cash. This amount amounts to $6 billion a year, before taxes and expenses.
What is most interesting about JPMorgan’s balance sheet is the fact that it is not putting its billions on the table. These are the four quarters:
JP did not add to its securities portfolio recently despite owning $1.2tn ($trillion!). More deposits than loans.
This could be interpreted in a way that is naive. JP may not find the current bond yields appealing, but B of A might. There is truth in that statement. These are the statements of both banks, beginning with BofA, according to its most recent quarterly call. Chief Executive Officer Brian Moynihan
The deposits have surpassed $1.9tn, and loans total $900m. This difference must be used. It is possible to do so. . We are not betting or timing the markets. It’s just that we deploy it only when it is certain it will be there.
Jeremy Barnum (JPMorgan’s Chief Financial Officer) stated this:
From an economic standpoint, we favor a robust recovery. That’s pretty much the consensus view of us all, including our research team and Fed. This view corresponds to higher inflation as per the Fed’s target. It’s a view that is associated with higher rates. We are happy to remain patient in spite of this. . .
For the final punch line, click here. . . When you take into account all of Jamie’s tail-type talk, the convexity in the balance sheet and other factors, it is still clear that patience makes sense.
The “punchline”, or puntmaker, is betting that the rates will rise. Is that a sign that B of A is placing the exact opposite wager? It could, although B of A does not see it this way. The company has an underlying policy that deploys extra cash to get the highest safe yield and then lets the chips fall as they please.
There are many reasons why the contrast may not be as stark or as dramatic as you think. Particularly:
Bank of America has hedged $150bn of its bonds using swaps. These swaps pay fixed and receive floating. These bonds, which are essentially cash after deducting the cost of swaps, only yield a few basis points less than Fed deposits.
Bank of America’s deposit base is very retail-dominated and sticky. JP has a more corporate deposit base and must be more concerned about the money being taken away in the event of a change in the economy.
JPMorgan’s capital requirements are closer than that of B.A. JP could hold more bonds and account for them as “available to sell”, but the capital would be wiped out. However, it wouldn’t flow through the balance sheets. Barnum mentioned the “convexity” of the balance sheets above.
Both banks are now able to shift their portfolios of securities towards “held until maturity” accounting — rates will not affect capital. However, banks can’t sell securities to raise capital unless they have all unrealised losses. It is a good idea to keep a few hundred billion in AFS just in case.
Charles Peabody from Portales Partners told me that JPMorgan is absolutely making it big in trading and investment banking (revenue of $10 billion in the second quarter). After the financial crisis BofA had to take some hard decisions and now makes about half of its revenue in capital markets. JP is able to remain patient as long as the capital markets are strong.
This raises interesting questions about valuation. What strategy should an investor choose? Should they redeploy cash as soon as possible to get every basis point in yield or wait for the right opportunity? David Konrad from KBW said to me that he would rather own a bank with a low-earning — JP, that is, JP, than one that has high earnings. JP also has profit potential in reserves, which means that the earnings that they have can be even greater. Although this is logical, there’s more to the JP strategy than it seems. If rates fall or stay flat, JP will lose some of their potential for making a lot of money. Flat-footed B of A is my favorite approach.
JP trades at tangible book value of 2.3 to B.O.’s 1.8. However, I don’t know how many people care about the different strategies in their balance sheets.
A good book
The Sunday New York Times offers an intriguing look into what happened to IBM’s Watson AI product following its triumph on Jeopardy. It is fascinating to see the struggles of IBM. This company has reinvented itself many times. My view was that the 2012 EPS goal of $20 by IBM marked the beginning of the end.
Most companies don’t believe that increasing profit sustainably is possible. It can be an outcome of doing something else. Profits are not the main mission of a company. This is a risk to your profitability. Wall Street is expecting IBM to make a mere $11 per share in the coming year.
Publié Mon, 19 July 2021 at 05:30.48 +0000