Banks Are Finally Making Money Again | Chris Whalen

Episode Summary

Executive Summary: Chris Whalen argued that bank earnings are being reshaped by higher rates: commercial banks with strong deposit franchises and lending discipline should benefit from wider net interest margins, while investment banks, non-bank lenders, REITs, and rate-sensitive securities holders face pressure from falling issuance, rising funding costs, and large mark-to-market losses on low-coupon bonds and MBS. He sees commercial real estate, not housing, as the next major credit problem.

Main Topics: Commercial banks vs. investment banks (Priority: 5/5): Whalen distinguished boring deposit-and-loan banks from market-facing dealers, arguing that the former are better positioned in a higher-rate world while the latter are losing the 2020-21 capital markets windfall. Quantitative easing’s distorted effects (Priority: 5/5): He argued QE flooded the system with inert reserves, boosted speculative activity and capital markets revenues, but did not meaningfully stimulate real lending; now higher rates are revealing the limits of that model. Credit outlook and recession risk (Priority: 5/5): Current credit losses remain low, but Whalen expects normalization and eventual deterioration as consumers’ balance sheets weaken and recession pressure spreads into commercial real estate and leveraged finance. Mortgage-backed securities and duration losses (Priority: 5/5): A major concern is not credit defaults but mark-to-market losses on low-coupon MBS and bonds bought during 2020-21, which he says have left some institutions functionally insolvent. Which banks are best positioned (Priority: 4/5): He favored main-street lenders such as U.S. Bancorp, Wells Fargo, and smaller efficient banks like Bank of the Ozarks, while warning that Goldman Sachs, Citi, and other market-facing names face tougher quarters. Commercial real estate stress (Priority: 5/5): Whalen expects substantial restructuring in office and other commercial property markets, especially where rents, occupancy, and refinancing capacity have deteriorated. Credit Suisse and European banking risk (Priority: 3/5): He said Credit Suisse is unlikely to fail outright but likely to shrink back toward private banking, with its structured products and mortgage-related businesses likely sold or rehomed.

Key Arguments: Higher rates improve traditional banks' net interest margins because bankers will now lend at coupons that were too low to justify risk during the zero-rate period. Quantitative easing created large bank reserves and inflated capital markets activity, but those reserves were largely unusable for productive lending. Commercial banks are already seeing loan growth resume as rates rise, while deposits may run off without hurting profitability if the remaining base is core commercial funding. The next real credit stress is likely to come from commercial real estate, leveraged loans, CMBS, and non-bank financial firms rather than from residential mortgages. Banks have reduced direct risk after the GFC by originating less and requiring more equity, but this pushed leverage and volatility into non-bank lenders, REITs, and capital markets vehicles. Large losses are already embedded in securities books due to duration risk; many low-coupon MBS and Treasuries are far below par and may never recover. Investment banks benefited from pulled-forward activity in 2020-21, so year-over-year comparisons overstate apparent strength and sequential trends are more meaningful. Main-street lenders with stable, non-interest-bearing deposit franchises and efficient operations should outperform market-facing universal banks in the near term.

Data Points: Wells Fargo efficiency ratio: low 70s - Whalen said Wells is improving but still needs more cost reduction to compete with top banks. U.S. Bancorp non-interest-bearing deposits: 40% of deposit base - Used as an example of a profitable commercial deposit franchise. JPMorgan loan growth QoQ: +2% - Whalen cited rising loans at JPM as evidence lending is returning. JPMorgan deposit growth QoQ: -3% - Deposits were running off, which Whalen said banks can tolerate if funding mix improves. JPMorgan funding cost: below 30 bps - Estimated cost of funds for the whole bank versus total assets. Charles Schwab funding cost: 8 bps - Used as an example of extremely low-cost core deposits among asset gatherers. Federal funds rate: 3% with futures implying 4.9%-5% - Shown as the rising cost backdrop for bank funding. Morgan Stanley investment banking revenue: less than Q3 2020, 2019, 2018, and 2017 - Illustrated the severity of the capital markets downturn. Mortgage new production: below $2 trillion expected for the year - Whalen said this would be down about 60% year over year. Mortgage new production YoY: -60% - Used to show the collapse in mortgage origination volumes. Low-coupon MBS price decline: 15%-20% below original issue - Whalen said many 2020-21 securities are deeply underwater. Selected Ginnie Mae coupons: 1.5% coupons trading in the low 70s - Example of severe duration losses in low-rate mortgage securities. Fed balance sheet: $8-9 trillion - Used to argue the Fed is now relatively small versus outstanding public debt. U.S. public debt: $30 trillion - Whalen said this limits the relative impact of Fed actions. Bank of the Ozarks assets: $26 billion - He cited it as a highly efficient commercial real estate lender. Bank of the Ozarks efficiency ratio: 37% - Presented as evidence of strong cost discipline. Commercial loan underwriting: 50% loan-to-value / 50 cents equity in front - Whalen described post-GFC lending discipline for commercial properties. Fed remittances outlook: loss position for 5-6 years - He said the Fed will likely remit nothing to Treasury for years due to reserve costs exceeding portfolio income.

Pivotal Quotes: "The banks don't mind. Jamie would like to drop half a trillion dollars in assets in the next 12 months at J.P. Morgan." — Chris Whalen: Explaining that shrinking balance sheets can improve returns when reserves are unproductive. "If you picked up the phone from the Fed of New York and called the dealers and said, give me a bid on $10 billion, 1.5, they would put the phone down." — Chris Whalen: Describing how unattractive low-coupon mortgage-backed securities have become. "The main takeaway, Jack, is that quantitative easing did not stimulate lending." — Chris Whalen: Summarizing his view that QE distorted markets more than it helped real credit creation.

Implications: Expect stronger relative performance from efficient deposit-taking banks and weaker results for capital markets, REITs, and non-banks. The next stress point is likely commercial real estate and duration losses, not consumer credit.