Investors are turning away from traditional bank deposits in pursuit of higher-yielding money market funds.
Since the start of 2022, cash has been trickling out of bank deposits and into money market funds at an accelerating rate. We believe there are two likely causes for these deposit outflows: yield and perceived safety. Since the Fed began aggressively raising interest rates in 2021, banks have largely not matched rising interest rates with the yields offered on their deposits (AKA, deposit beta). While the average savings account yield has increased threefold in the past year from 0.13% to 0.39%, they are still significantly short of the 5.17% rate offered by the Fed’s overnight repo program. Similar assets such as asset-backed commercial paper (ABCP) also offer higher yields than bank deposits though with varying and potentially increased levels of risk. As more of these programs have been coming to market in recent months, they may be absorbing more cash. Additionally, we believe that public perception of an elevated risk of bank failure is another factor that is likely pulling cash out of (mostly) smaller banks. The panic induced by March’s collapse of several regional banks may have caused some to lose faith in their banking institutions and seek out alternate places to store their money. The fear of contagion from these bank failures, coupled with more attractive yields, may be responsible for the pattern of accelerating flows from bank deposits into alternate money market assets.
Companies fortify positions ahead of (potential) impending recession.
Companies appear to be hoarding cash, slightly reducing shareholder returns and generally slowing debt issuances. Taken together, this suggests companies are fortifying their balance sheets. Certain sectors have seen shrinking profit margins while others have seen little change. Some of the differences may be related to the impact of inflation on product pricing as well as lower growth in employee wages. Regarding wages, the ISM services sector reading is still above 50, but manufacturing – which tends to be a leading indicator of services – is below the line. With projections for more tenuous cash generation and reinforced balance sheets, corporate issuers seem to be acknowledging the reality that difficult economic conditions may be ahead.
Price and enterprise multiples move higher, potentially indicating weaker forward earnings.
In 2Q23, we saw both EV/EBITDA and P/E multiples of the S&P 500 (SPX Index) increase compared to the average multiples in the prior business cycle. This could mean that either company valuations and stock values have been increasing or that future earnings are projected to deteriorate. With companies reducing debt burdens as well as building cash reserves, we can conclude that overall enterprise value has not been increasing. Similarly, the SPX Index has hardly seen an uptick since the Credit Team’s previous Credit Market Update. This suggests that next year’s EBITDA and earnings will decrease compared to their current state, highlighting overall investor pessimism.
Consumer sentiment is down while home values and credit card balances continue to climb.
While average home prices declined slightly for several months, housing price growth has returned. Despite home values remaining elevated in comparison to both the average of the prior business cycle and the pre-recessionary high, month-over-month increases in home values have returned. As a result of increasing home prices, consumers have required larger mortgages, which is contributing to mortgages making up a growing proportion of real U.S. GDP. Despite homebuyers requiring larger mortgage loans, the category of Other Consumer Loans (which includes auto, personal, student, and other loans) appears to be plateauing. However, consumers appear to be more heavily reliant on credit cards and other revolving lines of credit as balances have continued to climb. It is likely that inflationary price increases have contributed to consumers’ increasing credit card balances and the recent increase in credit card payments that are more than 90 days past due. It is likely not surprising that as home prices continue to rise and consumers become more reliant on credit cards, overall consumer sentiment remains low. The most recent University of Michigan Consumer Sentiment reported May 2023 sentiment levels in line with or below those seen during the Global Financial Crisis. Consumers’ decreasing willingness to spend is likely due in part to recessionary fears in conjunction with persistent price increases on everything from groceries to homes and already elevated credit card balances.
Deposits are down, and credit conditions are tighter, but borrowers keep paying their mortgages.
The most recent loan officer survey has shown that across the board U.S. banks have begun to tighten their lending standards. Auto loan originations were down 13% in 1Q23 from the quarter prior with the largest declines coming from the lowest FICO score demographics (>659 down 19% vs <750 down 5%). While banks did continue to report loan growth in 1Q23, all of the banks continue to expect loan volumes to plateau and then decline over the coming year. This comes amid one of the first outflows of bank deposits in more than a decade which was caused by stress in the U.S. regional banking sector during the first quarter. According to the Federal Reserve, banks have seen deposit outflows for the last four quarters, which is the longest streak we have on record in our data set. With deposits down and lending conditions tightening, we would normally expect to see a deterioration of asset quality at the banks, however, this has yet to materialize. Quarterly results from the U.S. banks we cover show that asset quality continues to improve to record strength in the mortgage and commercial portfolios with no material increase in delinquencies for mortgages and continuously low levels of non-performing assets. Nevertheless, we have begun to see delinquencies in credit card and auto portfolios trend up, and the banks have begun to experience a mild uptick in net charge-offs. Credit card balances have been on the rise across the banking sector, so it is no surprise that delinquencies have begun to increase; for now, the bank’s larger dollar lending like mortgages appears very robust.
