A year after the US Federal Reserve started hiking interest rates, winners and losers from the end of the era of loose money are becoming clearer.
First-quarter results from the biggest US banks underscored how much they have benefited from both the arithmetic of higher rates and the crisis that savaged their smaller competitors when Silicon Valley Bank failed on March 10, just before the first anniversary of the Fed’s belated move to tackle inflation with rate rises.
Higher net interest income was the main source of gain for the big banks that have been able to drag their heels in passing on rate rises to clients without suffering the deposit flight that affected smaller firms in March.
JPMorgan alone is now expecting net interest income of $81 billion for this year, its chief financial officer Jeremy Barnum said on the firm’s first-quarter earnings call.
There were plenty of other areas of rate-related strength for big banks to highlight, however.
At Citigroup, chief executive Jane Fraser stressed the progress made by the bank’s treasury and trade solutions business, where first-quarter revenue of $3.4 billion rose by 31% compared with the same quarter the year before, helped by a 41% increase in rates income.
She also gave a shout-out to the “excellent performance” of the interest rate traders in the bank’s markets unit.
Fraser naturally tried to frame this in the context of a business model that can prosper in challenging markets, rather than one where some dealers rode their luck.
“The volatile market we have been seeing is from our perspective very good volatility,” she said, "because we are able to support our clients in rates, FX and commodity hedging, and it makes our risk flows much more diversified than our competitors… We are not taking positions."
Rates trading gains helped Citigroup to record an unexpected 4% rise in fixed income revenues to $4.45 billion, compared with a strong first quarter in 2022.
Many banks have unrealized losses on their holdings of safe government debt as a consequence of the last year of rate hikes
Bank of America was another relative fixed income trading winner for the first quarter, with a peer-group leading 29% rise in revenue, to $3.4 billion, over the same period last year.
But relative fixed income performance for the biggest Wall Street dealers in the first quarter of this year largely reflected differences in their business mixes.
Goldman Sachs suffered a 17% fall in fixed income revenue compared with the first quarter of 2022 in part because it did not repeat the commodity trading bonanza seen immediately after Russia invaded Ukraine last year, for example.
Like JPMorgan – where fixed income revenue at $5.7 billion was flat compared with 2022 – Goldman saw higher rates trading revenue in the first quarter this year, as did Morgan Stanley, which had a 12% dip in overall fixed income revenue to $2.57 billion.
Getting away with it
And it could be argued that BofA’s biggest win in the rate hike performance scorecard came from getting away with massive unrealized losses on its securities holdings.
Many banks have unrealized losses on their holdings of safe government debt as a consequence of the last year of rate hikes. BofA’s nominal losses are unusually large, however. Even after rates dipped due to concern about systemic threats to banks in March, BofA still recorded an unrealized loss of $103 billion on its debt securities holdings at the end of the first quarter.
CEO Brian Moynihan and chief financial officer Alastair Borthwick took great pains to explain their management of BofA’s balance sheet in their quarterly earnings call with analysts, and it seems to have worked.
They noted that the unrealized loss had fallen from $113 billion at the end of 2022, that it overwhelmingly reflects securities that are classified as held-to-maturity, and – crucially – they convinced analysts and investors that the bank’s deposits are both relatively stable and “sticky”, to use one of the banking buzzwords of 2023.
Borthwick delivered a narrative describing BofA’s recent interest rate risk-management voyage (to use more buzzwords): “Throughout 2020, as we put deposits to work, we took a number of actions to protect our capital, and that included a build-up in hold-to-maturity, better aligning our capital treatment with our intent to hold those securities to maturity.
"We also hedged rate risk in the available-for-sale book using pay-fixed, receive-variable swaps,” Borthwick told analysts. “As rates began to rise quickly throughout 2022, the value of our deposits rose. And, at the same time, the disclosed market value of the hold-to-maturity securities has declined, resulting in a negative market valuation on those bonds. That negative market valuation peaked in the third quarter, came down in the fourth quarter, and it's come down another $10 billion in the first quarter.”
So, nothing to see at BofA, move along folks.
A week after BofA’s polished earnings call performance, executives at First Republic delivered a textbook example of how not to calm investor nerves.
The headline data point of a loss of deposits of around $100 billion in the first quarter provided a solid reason for a further slump in First Republic’s share price. But the inability of the bank’s executives to describe a plausible way out of their interest-rate exposure conundrum exacerbated the renewed selling that took First Republic’s year-to-date stock fall to over 90%.
The bank’s problems lay primarily with its mortgage loan exposure, rather than the unrealized losses on debt security holdings that prompted deposit flight from Silicon Valley Bank, but a similar fate became inevitable.
Future winners
Banks aren’t the only financial services companies affected by higher rates, of course. Private equity firms face a challenging market for financing new deals as well as threats to the viability of their portfolio companies.
But you can’t keep a good alternative asset manager down, as Blackstone demonstrated on its first-quarter earnings call.
Lesser executives might have simply acknowledged the tough backdrop and stressed the dry powder that big asset managers retain to hunt for distressed corporate targets. Blackstone’s chairman Stephen Schwarzman and his heir apparent, president Jon Gray, made this point but added some twists.
Schwarzman highlighted that as an “asset light” manager of third-party capital, Blackstone cannot suffer a bank-style deposit run.
“We don’t take deposits,” he said. "I’ll say that again. We don’t take deposits."
Gray chose to frame the impact of the Fed’s rate-hike policy as presenting an historic opportunity for Blackstone’s private credit business.
“We're seeing the greatest demand today for private credit solutions, given higher interest rates and wider spreads," he said. "Coupled with the pullback in regional bank activity, this is a golden moment for our credit, real estate credit and insurance solutions teams.
“As regional banks experience outflows of deposits, we are seeing real-time opportunities to partner with them at scale, utilizing our insurance capital in areas like auto finance, home improvement lending and equipment finance,” he added.
Given their confidence in this once-in-a-generation opportunity, it seems only fair to place Schwarzman and Gray among the winners in the rate-hike performance scorecard.
