The safety margin of the U.S. banking system is not as large as it may seem.
The Rise in Delinquencies and Charge-offs
The rise in delinquencies and charge-offs is associated with extreme growth in loan payments, which doubled in a quarter from $146 billion in Q1 2022 to $300 billion in Q4 2023.
The magnitude of loan payments and the speed of their growth have proven to be sensitive to the real economy. The balance sheets of the most successful companies in the S&P 500 may not appear to be in trouble, but the financials of banks show that problems are mounting.
Future Outlook: Declining Margins
Banks have managed to increase net margins from 4% in Q1 2023 to 4.7% on average over the past 12 months by holding weighted average funding rates while lending rates have risen faster.
Going forward, margins will decline due to higher funding costs and provisioning costs.
Growth Disparity: Deposit Rates vs. Market Rates
Deposit rates grew slower than market rates on dollar liquidity due to excess liquidity accumulated during 15 years of monetary madness.
As of Q4 2023, the weighted average corporate and retail deposit rates were 2.22%, and the quarterly rate of increase slowed by half, from 0.38 pp from Q3 2022 to Q3 2023 to 0.19 pp in Q4 2023, according to the FDIC's own calculations. Weighted average rates are based on deposit mix, so the calculations take into account the maturity and type of deposits (non-interest-bearing deposits are included), but this metric is important in terms of determining the cost of borrowing.
Weighted average lending rates rose to 6.92% by Q4 2023, the highest since Q4 2007, up from 4.13% before the MPC tightening cycle. MPC transmission is very weak, as dollar liquidity rates rose 5.3 pp over the period while lending rates rose only 2.7 pp, closer to the rise in medium and long-term bond rates. The actual tightening is less severe than the rise in short-term liquidity rates, but even so, the economy is struggling to digest high rates.
There are risks of uncontrollable shocks as banks' asset degradation problems accumulate.
Conclusion
The U.S. banking system's safety margin appears weaker than perceived. Rising delinquencies, coupled with rapid loan payment growth, signal underlying fragility. Despite efforts to manage margins, declining profitability looms due to increasing costs. Disparities between deposit and market rates underscore sector complexities. With accumulating risks, proactive measures are crucial to address vulnerabilities within the banking system.