Chris Whalen on Big Bank Earnings and the Return of Credit Risk

Episode Summary

Executive Summary: Chris Whelan argues the banking stress after SVB was a liquidity surprise, but the bigger ongoing problems are structural: higher funding costs, hot-money deposit competition, duration losses on low-coupon securities, and rising credit risk—especially in commercial real estate. Big banks like JPMorgan look stronger because they manage duration and costs better, but the Fed’s balance-sheet policy still distorts bank economics.

Main Topics: Earnings and funding-cost pressure (Priority: 5/5): Big-bank earnings were strong, but Whelan says higher rates are sharply increasing banks’ funding costs, squeezing net interest margins even as loan yields rise. Deposit competition and hot money (Priority: 5/5): Banks are being forced to pay up for deposits or lose them to T-bills and other higher-yield options. The interview emphasizes the growing role of unstable, rate-sensitive funding. Duration risk and bond-market losses (Priority: 5/5): Low-coupon securities bought in 2020-21 remain a major issue because rising rates crushed mark-to-market values; falling rates recently improved the optics, but not the underlying problem. Credit risk and commercial real estate (Priority: 5/5): Whelan says the next major banking story will be credit deterioration, especially in commercial real estate, with some regional and legacy-city exposures much worse than others. Fed policy and quantitative tightening (Priority: 4/5): He argues the Fed’s rapid hiking and balance-sheet runoff distorted markets, created volatility, and should be unwound more symmetrically—potentially including active Fed sales of MBS. Hedging, balance-sheet strategy, and bank-model differences (Priority: 4/5): The conversation contrasts JPMorgan, Bank of America, Citi, Goldman, and others on hedging, duration management, and business model choices, with JPMorgan and U.S. Bancorp presented as best managed. Accounting, reserves, and loss recognition (Priority: 3/5): Banks book expected losses before defaults occur, so earnings and provisions depend on assumptions and can shift materially as credit conditions evolve.

Key Arguments: Banks’ core profitability is being squeezed because funding costs are rising faster than many loan yields can offset, even in a higher-rate environment. The real competition for deposits is not just other banks but 4%+ Treasury bills, forcing customers to demand yield on balances. Duration losses on securities bought at 2%-4% remain a medium-term drag on earnings, even if falling yields temporarily improve mark-to-market values. Commercial real estate, not residential mortgages, is the likely headline credit problem for banks over the next year. Not all credit is impaired equally: multifamily/legacy-city assets are under more stress than loans in stronger regions like Texas and the South. Large banks with short-duration balance sheets and tight expense control are better positioned than peers with longer-duration books and higher overhead. The Fed’s actions during QE and QT materially changed investor preferences and asset pricing, creating volatility that banks cannot fully hedge away. Hedging is often misunderstood: banks do not fully hedge held-to-maturity assets because those positions are meant to earn coupon income, not be traded. Credit losses are still historically low, but provisions should rise as charge-offs normalize and regulators force larger reserves. The recent crisis was partly about surprise; once markets and regulators understood the issue, panic subsided, but the underlying structural risks remain.

Data Points: Net interest income (JPMorgan): doubled over the last year - Whelan cites JPMorgan’s strong earnings and says higher rates helped expand lending income. Funding costs (JPMorgan): went up tenfold - Used to illustrate how sharply deposit/funding expenses have increased. Big-bank gross spread: about 5% - Whelan estimates the average spread for a large bank like JPMorgan. Funding cost estimate: 3.25% - Approximate funding cost subtracted from the gross spread. SG&A/overhead estimate: about 2 points - Illustrates how expenses consume much of the remaining spread. Deposit increase at JPMorgan: quarter over quarter increase; first since Q1 2022 - Presented as a sign of deposit strength at the largest banks. Wells Fargo bad-loan provision: $643 million - Example of reserve building for credit losses. Credit-card growth spread at Citi: in the teens - Shows Citi’s higher-yield, higher-risk lending profile. Credit-card growth spread at JPMorgan: 6 - Lower spread reflects lower-risk, lower-yield lending. Top-line peer efficiency ratio: about 59 - Whelan says JPMorgan is near the peer-group average for efficiency. Bank of America weighted average maturity: probably close to 20 years - Used to contrast BofA’s longer-duration posture with JPMorgan. JPMorgan weighted average maturity: less than 5 years - Shows JPMorgan’s shorter-duration management. Available-for-sale and held-to-maturity losses: about $1 trillion underwater in Q3; about half that this quarter - Whelan describes how higher rates affected bank securities books. Fed rate hikes: 450 basis points in a year - Referenced in discussion of duration losses and market volatility. Fed balance sheet / agency MBS exposure: about $2.5 trillion nominal face amount - Amount Whelan wants the Fed to sell back into the private market. Banking-system non-core funding dependence: doubled in a single quarter - Whelan sees this as a flashing warning sign missed by the Fed. Silicon Valley Bank MBS holdings: over $80 billion - Example of concentration in long-duration mortgage-backed securities. First Republic valuation: trading at 10 cents on the dollar to book value - Signals distress and likely consolidation.

Pivotal Quotes: "The basic economic disparity, which is banks can't make 4% pretty much anywhere on their platform right now, net of expenses and funding." — Chris Whelan: Explaining why banks are struggling to compete with Treasury-bill yields and rising funding costs. "You don't hedge an asset that you're going to keep in portfolio, what we call held to maturity. Why? Because you buy that asset on credit." — Chris Whelan: Defending his view that hedging is often misunderstood for held-to-maturity securities. "The headline is going to come from commercial exposures, restructuring the legacy cities, particularly New York City, obviously." — Chris Whelan: Identifying commercial real estate as the next major banking stress point.

Implications: Banks face a slower, more expensive funding environment and rising credit losses, especially in commercial real estate. Stronger operators should outperform, but the Fed’s policy path will remain the key driver of bank earnings, volatility, and consolidation.