Chris Whalen: “Higher For Longer” Interest Rate Regime Is Bad For Banks

Episode Summary

Executive Summary: Chris Whalen argued that bank earnings are being squeezed less by absolute rate levels than by spreads, duration risk, and funding competition. He sees commercial real estate—especially multifamily and offices in politically constrained markets—as the main 2024 credit issue, while consumer credit remains manageable. He also expects banks to shrink balance sheets and adapt to a higher-for-longer world.

Main Topics: Q1 Bank Earnings and Net Interest Pressure (Priority: 5/5): Whalen said large bank results were broadly in line with his prior view: fee income and trading helped, but net interest income remained flat to down as spread compression continued across the industry. Commercial Real Estate as the Main Credit Problem (Priority: 5/5): He argued the real stress point is commercial real estate, especially idiosyncratic office and multifamily exposures, with refinancing pressure, tenant weakness, and falling asset values creating ongoing trouble. Balance Sheet Duration and Interest-Rate Risk (Priority: 5/5): Whalen stressed that banks mismanaged the COVID-era rate shock by holding long-duration assets bought at low coupons, and that higher-for-longer rates still threaten mark-to-market values and funding costs. Deposits, Funding Mix, and Regulatory Behavior (Priority: 4/5): He discussed how banks are increasingly wary of consumer deposits because they can flee quickly in the smartphone era, and may prefer more expensive but stabler term debt or institutional funding. Regional vs Large Banks and Business Model Differences (Priority: 4/5): Whalen differentiated between large banks with capital markets businesses and smaller banks focused on traditional lending, arguing that midsize banks may outperform because they price assets better and keep less duration risk. New York Community Bank and Multifamily Politics (Priority: 5/5): He viewed NYCB’s problems as a combination of bad disclosure, multifamily exposure, and hostile rent-control policy in New York, saying the issue is political and will require capital and likely a broader resolution. Private Credit and Competitive Asset Pricing (Priority: 3/5): He noted that deal financing has migrated away from bank loans and high-yield markets toward private credit, but warned that abundant liquidity still forces lenders to compete by accepting lower coupons for assets.

Key Arguments: Bank profits are being driven more by spread dynamics than by nominal interest-rate moves; rate increases do not automatically help earnings. The first quarter benefited from trading and fee income because rates fell from October to quarter-end, boosting origination activity and refinancing. Commercial real estate is the key risk area in 2024; office weakness is obvious, but multifamily is also impaired by rent control, higher rates, and falling asset values. Large banks do have meaningful CRE exposure, but their businesses are diversified enough that CRE is only part of the story. The post-COVID rate shock created severe duration losses on mortgage-backed and other fixed-income assets, and many banks failed to reposition fast enough. Consumer deposits are becoming less attractive as a stable funding source because they can move instantly; institutions may increasingly rely on term debt or brokered funding. Midsize banks may outperform because they maintain stronger asset pricing discipline, smaller securities books, and lower duration risk. NYCB’s issues reflect both portfolio risk and political/regulatory constraints, making a capital raise and eventual restructuring likely. Private credit and other liquidity-rich competitors are compressing yields by bidding aggressively for assets, which limits banks’ ability to earn higher returns. Consumer credit has not yet become a major balance-sheet problem; auto and credit card delinquencies are rising but remain below levels that would signal a recession.

Data Points: Average yield on Bank of America securities portfolio: Less than 3% - Whalen said BofA’s $840 billion securities book was yielding under 3%, illustrating duration drag. Size of Bank of America securities portfolio: $840 billion - Whalen used this figure to show how much low-yielding assets remain on the balance sheet. Bank of America real estate loans: $72 billion - He cited this as roughly 7% of BofA’s $1 trillion loans and leases. Commercial real estate share of BofA loans and leases: 7% - Used to argue that CRE exposure exists but is not the entire balance sheet. Office loans as share of BofA loans: 2% - Whalen said office exposure alone cannot be the whole banking-system story. Schwab securities book yield: 2.12% in March 2023 and 2.12% in March 2024 - He noted the yield barely changed, underscoring long-duration holdings. Deposit cost comparison: Schwab cost of funds roughly half of large banks - Whalen said Schwab’s cheap deposits help offset low-yield assets. Rate move since COVID lows: Up 5 to 6 percentage points - He used this to explain why asset values and cap rates reset sharply. Cap rates on real estate: 6% to 8% rather than 2% to 4% - Whalen said higher rates imply materially lower property values if net income is unchanged. Mortgage rates during the discussed period: Fell about 1 point in a quarter - He linked the rate rally to improved refinancing and fee income in Q1. Potential 10-year Treasury level: 5% - Whalen warned a return to 5% would create renewed mark-to-market pressure. Possible Fed funds outcome: Around 5% or slightly below - He argued this may be an acceptable steady state if rates stay higher for longer. Potential mortgage rate level by year-end: 7% to 7.5% - He said this would resemble a 1990s-style low-volume housing market. NYCB ranking in Whalen’s index: Previously around the high 20s; later near the bottom - He said the restatement severely damaged the bank’s standing. Multifamily loss rate: Around 100% on defaults - Whalen said multifamily losses had normalized back to crisis-like levels. Potential bank size target for Schwab: $200 billion - He predicted Schwab could shrink its bank subsidiary to this level. Tapering balance sheet / rate cuts outlook: About one cut this year, possibly in Q4 - He suggested the market had walked back earlier expectations for multiple cuts.

Pivotal Quotes: "The real weakness for all of these banks to one degree or another is return on earning assets." — Chris Whalen: Explaining why Q1 bank results were held back despite stronger trading and fee income. "The theme for 2024 is commercial." — Chris Whalen: Summarizing his view that commercial real estate is the dominant credit issue for banks this year. "If you got Fed funds down into the mid-fours, four and three-quarters, it would actually take a lot of pressure off lenders." — Chris Whalen: Describing how even modest rate cuts could ease funding and asset-pricing stress.

Implications: Banks may need to shrink, extend less, and manage duration far more conservatively. CRE stress will likely surface gradually through restructurings and capital raises, while consumers stay mostly stable for now. Higher-for-longer rates should favor disciplined midsize lenders over large balance-sheet-heavy banks.