John Toohig & Nate Stovall: Bank Loan Market Is “Very Frozen”

Episode Summary

Executive Summary: The discussion centered on banks entering earnings season facing margin compression, rising deposit costs, and slowing loan growth, while credit quality remains better than feared. John Tuhigg and Nate Stovall argued that higher-for-longer rates, a steep rise in long-term yields, and weak mortgage/CRE liquidity are pressuring funding and earnings more than credit losses, with potential normalization, M&A, and selective asset sales unfolding into 2024.

Main Topics: Bank earnings pressure: margins, funding, and liquidity (Priority: 5/5): Both guests said banks are seeing net interest margin pressure from higher deposit costs and slower loan growth, with community and regional banks especially short on liquidity and hunting for funding. Deposit betas and the shift in funding mix (Priority: 5/5): Nate explained that deposit betas on interest-bearing funds are running above 100%, while non-interest-bearing deposits keep shrinking, forcing banks toward expensive CDs and brokered funding. Long-end rates, mortgage markets, and loan liquidity (Priority: 5/5): John argued that the rise in long-term rates is hurting borrowers and freezing mortgage liquidity, reducing originations, prepayments, and cash coming back into institutions. Credit remains resilient despite recession fears (Priority: 4/5): Despite worries about consumer strain and CRE stress, both said credit quality is still holding up better than expected and remains below or near pre-pandemic stress levels in many areas. Commercial real estate and selective selling/marking (Priority: 4/5): CRE is a major concern, but the panel emphasized nuance: office is the hardest-hit segment, while many C&I loans are backed by CRE collateral and some assets remain cash-flowing. Balance-sheet marks, HTM/AFS, and regulation (Priority: 4/5): They discussed unrealized losses on securities portfolios, how HTM and AFS are treated differently, and how Basel III endgame may broaden regulatory capital sensitivity to bond marks. 2024 outlook: normalization, M&A, and possible repricing (Priority: 4/5): The guests expect a slow grind rather than a crisis, with more reserve building, possible earnings pressure, and increased bank M&A if boards decide they need to act.

Key Arguments: Margin compression is being driven primarily by rising deposit costs and slowing loan growth, not by catastrophic credit deterioration. Deposit betas are unusually high because banks are competing aggressively for funding and customers are moving cash from non-interest-bearing balances into higher-yielding products. Long-term rates rising toward the short end do not necessarily help banks, because the resulting mortgage-rate spike reduces loan production and liquidity. The mortgage market is structurally weaker due to low prepayment speeds, fewer refinancings, and a roughly halved origination market versus 2021-22. Credit is not yet behaving like a recessionary crash; delinquencies and charge-offs are generally still below pre-pandemic averages in many portfolios. Commercial real estate is under stress, but the situation is highly segmented by property type, geography, sponsor strength, and loan structure. Unrealized securities losses are an economic and earnings issue even when not realized; they also matter for liquidity perception and, in some cases, regulatory scrutiny. The current environment feels more like an interest-rate shock and earnings squeeze than the 2008 financial crisis, so banks may be able to earn their way through it. M&A may increase in 2024 because boards facing weak earnings growth may prefer consolidation over waiting for a rebound. If rates stay high for an extended period, bank funding costs keep rising, but the Fed may eventually pivot if slower growth and lower inflation emerge.

Data Points: Deposit beta (interest-bearing funds, median): 118% - Nate said the median deposit beta seen in earnings has been about 118%, above the 115% built into models. Deposit beta modeled: 115% - S&P Global model assumption for interest-bearing deposit repricing. Non-interest-bearing deposits decline since end-2021: 26% - Industry-wide decline in free deposits since year-end 2021. Industry deposit outflows in 2022: 2% - Nate noted deposits declined 2% across the industry in 2022. Interest-bearing deposit cost, Q2: 2.35% - Industry aggregate interest-bearing deposit cost in Q2. Interest-bearing deposit cost forecast peak: 3.05% - Nate projected interest-bearing deposit costs topping out just over 3% in Q1. CD market pricing: 4% to 5% handles - Banks are widely offering CDs in the 4-5% range to attract funding. Banks with 4%+ CDs in market: ~700 banks - Nate cited nearly 700 banks offering 4%+ CDs. 2-year Treasury yield: 5.21% - John cited the 2-year at 5.21% during the conversation. 10-year Treasury yield: 4.90% - John cited the 10-year at 4.90%. Yield curve inversion: ~30 bps - John said the curve was about 30 basis points inverted at that moment. Peak inversion earlier in year: Almost 100 bps - John said the curve had been inverted by nearly 100 basis points around mid-year. Mortgage origination market (2021-2022): ~$4 trillion - John described the peak mortgage origination market size in 2021-22. Current/expected mortgage originations: ~$1.7-$1.8 trillion - MBA forecast and John’s estimate for the current year, roughly half of peak volumes. Loan-to-deposit caveat: Not a true liquidity measure - John argued liquidity requires looking at maturities and marks, not just loan-to-deposit ratios. Held-to-maturity securities at G-SIBs: ~70% of securities portfolios - John said the largest banks have heavily used HTM to avoid capital volatility. HTM share at smaller banks: ~25% of securities portfolios - John said smaller banks also use HTM, but less heavily. Bank of America HTM unrealized losses: $130 billion - Jack referenced BofA’s HTM unrealized loss figure as an example of underwater portfolios. Cecil reserve volatility in 2020: $60 billion headwind - Nate said CECL reserve building created a roughly $60 billion earnings headwind in 2020. CECL reserve release in 2021: $58 billion benefit - Nate said reserves flowed back to earnings in 2021. Corporate excess savings revision: Hundreds of billions higher - Nate said the San Francisco Fed revised excess savings higher by a couple hundred billion. Consumer/student loan repayment burden: 24 million Americans, $300-$350 per month - Nate said student loan repayment restart could weigh on spending. CRE concentration threshold: 300% of risk-based capital - Nate said banks above this level face increased scrutiny. Regulatory liquidity concern threshold: Below 5% tangible common equity - Nate said regulators begin “kicking the tires” on liquidity/exam ratings under this level. Bank earnings outlook: Down ~10% this year, a bit more next year - Nate forecast earnings pressure as margins and reserves weigh on results.

Pivotal Quotes: "Margins compressing, deposit costs rising, loan growth slowing, credit largely holding" — John Tuhigg: John summarized the core bank earnings backdrop at the start of the conversation. "The cycle keeps on going, going, going, and we're looking for clues to when this recession we talked about every single day is going to hit, but we still really haven't seen it yet in terms of credit." — Nathan Stovall: Nate explained why credit fears have not yet translated into broad loan losses. "It is an interest rate shock. It's not a credit issue. It's not a credit issue." — Nathan Stovall: Nate contrasted the current environment with the 2008 financial crisis.

Implications: Banks likely face a prolonged earnings squeeze, not an immediate systemic crisis. Expect slower growth, more expensive funding, tougher CRE/mortgage conditions, possible reserve builds, and more M&A or asset sales if rate relief does not arrive soon.