Investors in big US banks are braced for a fresh round of disclosures on energy portfolios as regulators turn up the heat on lenders to take a more critical look at likely losses.
Despite a recent recovery in the price of oil, which has climbed more than 50 per cent from its February low, the biggest four banks by assets in the US are set to reveal more trouble among borrowers as they report first-quarter earnings this week.
Analysts at Barclays note that results for January to March are likely to reflect tougher guidance from a trio of bank regulators.
The Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency have insisted that banks take a more comprehensive look at borrowers’ indebtedness — including junior liens and unsecured debt — when assessing their own positions.
JPMorgan Chase opens the reporting season on Wednesday, followed by Bank of America and Wells Fargo on Thursday and Citigroup on Friday.
“The recent rally in oil prices could reduce the severity of the pressure but credit migration and reserve builds will continue,” said Ken Usdin, analyst at Jefferies in New York.
The banks’ share prices have been under pressure since the turn of the year, weighed down by a combination of fears over slowing global growth and the effects of gyrating capital markets.
Analysts expect banks’ trading and investment banking businesses to record their worst first quarter since 2009, in terms of revenues.
Meanwhile, the trouble in the oil patch has already inflicted particular damage on banks exposed to energy with lenders including JPMorgan, Comerica and BB&T pre-announcing hits to earnings in recent months.
Such concerns are likely to remain in focus this week, as banks disclose bigger buffers against losses and discuss the effects of cuts to customers’ lines of credit, which are typically based on the value of reserves in the ground.
As borrowers stop spending on exploration to conserve cash to service debts, the value of their oil reserves falls too — and hence the size of their credit lines from the banks, which are usually reassessed every six months.
One senior executive at a big Wall Street bank, speaking on condition of anonymity, said that he expected cuts to reserve-based loans of about 15 to 20 per cent during the current redetermination season.
That is the third big round of reductions since oil first dipped below $70 a barrel in November 2014 and is likely to intensify a funding squeeze for the most cash-strapped borrowers.
Haynes and Boone, a Dallas-based law firm, has tracked 59 bankruptcies among North American oil and gas producers since the beginning of last year, involving about $19bn in cumulative secured and unsecured debt.
“All indications suggest many more filings will occur this year,” said Buddy Clark, a partner at the firm.
Fears over asset quality will continue to drag on banks’ share prices, said Fred Cannon, global director of equity research at Keefe, Bruyette & Woods.
“I always say, you want to own the banks when they’re making bad loans — not when they’re collecting them.”
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Negative interest rates, one of the latest central bank experiments to goad economies back into growth, got low marks at a financial and economic conference along Lake Como.
Richard Koo, the chief economist at Nomura Research Institute, said such rates were “intellectually bankrupt,” in an interview at the Ambrosetti Workshop in Cernobbio, Italy on Friday. Olivier Blanchard, the former chief economist at the International Monetary Fund in Washington, told Bloomberg Television they interfere with banks’ business in “very complex” ways.
The Bank of Japan surprised markets by adopting negative interest rates in January, more than a year and a half after the European Central Bank became the first major institution of its kind to venture below zero. The ECB reduced its deposit rate further to minus 0.4 percent in March.
The BOJ’s decision to adopt negative rates has failed to rein in the currency’s 11 percent rally this year. Thomas Kressin, Munich-based head of European foreign exchange at Pacific Investment Management Co. said at Bloomberg’s FX16 conference in London this week that the policy has “backfired.”
Side Effects
Blanchard said central banks should focus on quantitative easing rather than rate cuts if more stimulus is needed to boost their economies. He also said it’s too early to make a final judgment on negative rates, and they have side effects.
“I don’t like it, I think it interferes with the business of banks in ways that
are very complex,” said Blanchard, now a senior fellow at the Peterson Institute for International Economics in Washington. “If they do something on the macro side, I much prefer what we now call regular QE.”
Nouriel Roubini, co-founder and chairman of Roubini Global Economics, told Bloomberg in Cernobbio that negative rates “are becoming counter-productive.”
“We are reaching the limits of what monetary policy can do and we have to have the use of fiscal policy.” Roubini said.
Even ECB Executive Board member Yves Mersch said that policy makers appreciate the complexity of negative interest rates.
“The public might even consider that further cuts would announce further doom down the road,” Mersch said in interview with CNBC in Cernobbio.
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Negative interest rates risk hitting consumer spending and undermining the economic growth they are intended to encourage, the head of the world’s largest asset management group has warned.
Larry Fink, chief executive of BlackRock, said that not enough attention was being given to the effect of negative rates on saving habits in a downbeat annual letter to his shareholders.
His intervention came as the International Monetary Fund added fuel to the debate on what effect negative interest rates were having on the global economy by warning that there were “limits on how far and for how long negative policy rates can go”.
The fund said the introduction of negative policy rates by central banks such as the Bank of Japan had been broadly positive so far, but highlighted the danger of reaching a tipping point where people would start to hoard cash.
The Bank of Japan, the European Central Bank and four other central banks around the world have introduced overnight negative interest rates in an effort to bolster growth and raise inflation expectations. The monetary policy experiment is designed to encourage banks to lend, but its introduction has been accompanied by doubts over its effectiveness, concern about its effects on bank profitability and by widespread volatility in financial markets.
The comments come ahead of this week’s spring meetings of the IMF and World Bank, where the fund is widely expected to further revise downwards its 3.4 per cent global growth forecast for this year.
Mr Fink said that low rates were preventing savers from getting the returns they needed to prepare for retirement, so they were increasingly being forced to divert money from current spending into savings.
“There has been plenty of discussion about how the extended period of low interest rates has contributed to inflation in asset prices,” he wrote. “Not nearly enough attention has been paid to the toll these low rates — and now negative rates — are taking on the ability of investors to save and plan for the future.”
A typical 35-year-old had to save more than three times as much to make the same retirement income when long-term interest rates were at 2 per cent than when they were at 5 per cent, said Mr Fink.
“This reality has profound implications for economic growth: consumers saving for retirement need to reduce spending … A monetary policy intended to spark growth, then, in fact, risks reducing consumer spending.”
In a blog post published on Sunday, José Viñals, the IMF’s top financial stability watchdog, and his co-authors said their analysis showed the economic benefits of the broad boost to demand from negative rates outweighed the potential costs.
But they also warned that there were limits to how far into negative territory rates could go before they started encouraging both companies and individuals to hoard cash.
There was also at least one piece of evidence that some of that hoarding may have already begun, the IMF economists wrote, with demand for bank notes rising in Switzerland, where the central bank introduced negative rates in December 2014.
“It’s important to emphasise that, while monetary policy is critical to the battle against weak growth and deflationary pressures, there appear to be limits on how far and for how long negative policy rates can go,” they wrote.
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The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2016 is 0.1 percent on April 8, down from 0.4 percent on April 5. After this morning’s wholesale trade report from the U.S. Bureau of the Census, the forecast for the contribution of inventory investment to first-quarter real GDP growth fell from –0.4 percentage points to –0.7 percentage points.
More than 40% of Americans who borrowed from the government’s main student-loan program aren’t making payments or are behind on more than $200 billion owed, raising worries that millions of them may never repay.
The new figures represent the fallout of a decadelong borrowing boom as record numbers of students enrolled in trade schools, universities and graduate schools.
While most have since left school and joined the workforce, 43% of the roughly 22 million Americans with federal student loans weren’t making payments as of Jan. 1, according to a quarterly snapshot of the Education Department’s $1.2 trillion student-loan portfolio.
About 1 in 6 borrowers, or 3.6 million, were in default on $56 billion in student debt, meaning they had gone at least a year without making a payment. Three million more owing roughly $66 billion were at least a month behind.
Meantime, another three million owing almost $110 billion were in “forbearance” or “deferment,” meaning they had received permission to temporarily halt payments due to a financial emergency, such as unemployment. The figures exclude borrowers still in school and those with government-guaranteed private loans.
The situation improved slightly from a year earlier, when the nonpayment rate was 46%, but that progress largely reflected a surge in those entering a program for distressed borrowers to lower their payments. Enrollment in those plans, which slash monthly bills by tying them to a small percentage of a borrower’s income, jumped 48% over the year to 4.6 million borrowers as of Jan. 1.
Advocacy groups, some members of Congress and the federal Consumer Financial Protection Bureau fault loan servicers—companies the government hires to collect debt—for not doing enough to reach troubled borrowers to offer such payment options.
“The servicers aren’t quite promoting them in the way they should be—I think some of it’s information failure,” said Rachel Goodman, a staff attorney at the American Civil Liberties Union.
But the picture seems more complicated.
Navient Corp. , which services student loans and offers payment plans tied to income, says it attempts to reach each borrower on average 230 to 300 times—through letters, emails, calls and text messages—in the year leading up to his or her default. Ninety percent of those borrowers, which include federal borrowers as well as those who hold private loans, never respond and more than half never make a single payment before they default, the company says.
The Obama administration—worried about taxpayer costs and the prospect of consumers damaging their credit by defaulting—has stepped up efforts to reach borrowers and offer the income-based repayment plans. In some cases, the government is garnishing wages and tax refunds of borrowers who refuse to pay.
Education Department officials note that some defaulted loans are from prior decades and, unlike private lenders, the government is severely limited in its ability to write them off and remove them from the books. They also point out that the growth in defaults and delinquencies slowed last year, suggesting progress in the administration’s efforts to get borrowers current.
But the officials acknowledge that a large pool of borrowers have essentially fallen off the radar. The Education Department has assembled a “behavioral sciences unit” to study the psychology of borrowers and why they don’t repay.
“We obviously have not cracked that nut but we want to keep working on it,” said Ted Mitchell, the Education Department’s under secretary. He said many defaulted borrowers dropped out of school and are underemployed.
Carlo Salerno, an economist who studies higher education and has consulted for the private student-lending industry, noted that the government imposes virtually no credit checks on borrowers, requires no cosigners and doesn’t screen people for their preparedness for college-level course work. “On what planet does a financing vehicle with those kinds of terms and those kinds of performance metrics make sense,” he said.
Some borrowers aren’t repaying even when they can. Research from Navient shows that borrowers prioritize other bills—such as car loans, mortgages and heating bills—over student debt. A borrower who fails to pay down an auto loan might have her car repossessed; with student loans, there is no such threat.
Kristopher Mathews, 38 years old, is in deferment on about $11,900 in federal student loans. During the recession he earned a certificate at a Michigan-based for-profit college that teaches media arts, but he wasn’t able to find the well-paying job in radio that he hoped for.
Mr. Mathews now works as a logistical analyst for an auto company, making $46,000 a year. He says he devotes his income to caring for his family—he and his fiancée have three children—and paying off two credit cards and a car loan. “With all the other necessities in life I just don’t have” funds to pay student debt, he said.
Once his deferment expires, he isn’t sure if he will feel obliged to pay down his loan. “They promised me everything,” he said of his for-profit college. “And I honestly have nothing to show for it except a piece of paper that doesn’t really do me any good.”
Most borrowers who have defaulted owe relatively little—a median $8,900, according to the Education Department.
The administration maintains that the student-loan program, as a whole, will generate a profit over the long term, but the risk is rising that its revenue won’t meet the administration’s projections.
Even many borrowers who are current on their loans are paying very little. More than a third of borrowers on an income-based repayment plan had monthly payments of zero because their incomes were so low, according to a Navient survey last year.
The Education Department, through private debt-collection agencies, garnished $176 million in Americans’ wages in the final three months of last year for student debt, federal data show.
The administration’s pursuit of troubled borrowers is drawing criticism from student advocates and their allies in Congress. Last week, the American Civil Liberties Union and the National Consumer Law Center sued the Education Department, accusing it of blocking public access to data on the agency’s debt-collection efforts. The groups suggested that the companies collecting debt for the department might be discriminating against black and Hispanic borrowers.
Dorie Nolt, a spokeswoman for Education Secretary John B. King Jr., said the agency is reviewing the groups’ public-information requests.
“The singular goal of our student loan program is to help all students get a degree that sets them up for success, and we take the treatment of our borrowers—particularly historically underserved students—very seriously,” Ms. Nolt said in an email.
The global corporate default has climbed to its highest level in seven years, led by oil and gas companies.
This week saw four new corporate defaults, which took the overall tally to 40 for 2016, ratings agency Standard & Poor’s said. That’s the highest year-to-date default tally since 2009. Of those, 14 defaults came from the oil and gas sector, and a further eight from the metals, mining, and steel sector. The overall default tally for the same time last year was 29.
Companies in the US saw the biggest default rate with 34, with five in the emerging markets.
Things could get worse, if the words of SocGen’s Albert Edwards are to be believed, with the French bank warning of a “tidal wave of corporate default” in the US.
Stripping out troubled energy and mining sectors, however, the default rate is at a post-crisis low, as investment house M&G pointed out this week.
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I have my grandfather hat on today so blogging will be light. This Bloomberg story , however, is newsworthy as it shows that participants are quite long fixed income.
Via Bloomberg:
RATES: Most Net Longs Since 2013 in Latest JPM Survey
2016-04-05 11:30:14.366 GMT
By Robert Elson
(Bloomberg) — The JPMorgan Treasury Client Survey for the
week ended April 4 vs week ended Ar. 28.
* Longs 23 vs 18
* Neutrals 61 vs 64
* Shorts 16 vs 18
* Net longs 7 vs 0
* “The all clients survey shows the most net longs since
November 18, 2013”
* Active clients survey:
* Longs 50 vs 30
* Neutrals 40 vs 60
* Shorts 10 vs 10
* Net longs 40 vs 20
* “The active clients survey shows the most net longs
since November 1, 2010”
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Investors plowed cash into long-VIX securities since Feb. 11
Fear gauge has plunged 52 percent over the same period
Some of the most popular securities in the equity market have been at the center of some of its most misguided trades.
Consider the last six weeks, when investors poured a record $2 billion into exchange-traded notes that track volatility in the Standard & Poor’s 500 Index. The securities, which are bought and sold like stock and appreciate when turbulence rises in the market, lost half their value during the stretch as a rebound in U.S. equities added more than $1.5 trillion to share prices.
The securities, with daily volume that is usually twice that of Apple Inc. or Microsoft Corp., have repeatedly proven a graveyard for bears — though rarely to the extent they did in March. It’s a testament to the hazards of market timing and shows how violently the resilience of American equities has blindsided the most sophisticated traders over the last two years.
“The market has a way of humiliating as many people as it can,” said Steve Sosnick, an equity risk manager at Timber Hill, the market-making unit of Greenwich, Connecticut-based Interactive Brokers Group Inc. “Consensus trades like this, especially when they’re contrarian, often don’t pan out.”
Trading in the notes has exploded as the bull market plodded on. The biggest, iPath’s S&P 500 VIX Short-Term Futures ETN, has seen average daily volume of more than 80 million shares in 2016, up from 57 million last year. In 2011, two years after the note was launched, average volume was less than 2 million shares a day.
To be sure, not everyone buying the notes is taking a directional view on equities. The ETNs are used by high-frequency traders to balance their holdings and by bullish investors trying to hedge against losses. But the propensity over the last six years for demand to surge just before the VIX tumbled is uncanny.
Among the country’s most heavily traded stocks, volatility notes are issued by banks and use a hodgepodge of derivatives and futures to track the ups and downs in the Chicago Board Options Exchange Volatility Index. Owning one amounts to a bet that stocks will fall since the VIX moves in the opposite direction of equities about 80 percent of the time. VIX futures expiring this month slipped at 6:26 a.m. in New York.
Unfortunately for traders who bought one in mid-February, the S&P 500 has gone virtually straight up in the weeks, surging 13 percent. The gauge’s recovery from an 11 percent decline to start the year marked the first time since 1933 it finished a quarter higher after falling at least 10 percent. The S&P 500 climbed 6.6 percent in March, its biggest increase since October.
The iPath VIX ETN has absorbed $810 million in fresh capital since Feb. 11, while shares outstanding on the note sit close to the highest since August. The ProShares Ultra VIX Short-Term Futures ETF received $995 million of cash over the same period, while the VelocityShares Daily 2x VIX Short Term ETN, or TVIX, attracted $337 million.
Shares outstanding on the ProShares and VelocityShares securities sit just below record levels — and each has lost two-thirds in price since mid-February after the drop in the S&P 500 suddenly reversed.
“There was a lot of speculation on the potential extent of the decline,” said John Carey, a Boston-based fund manager at Pioneer Investment Management Inc., which oversees about $230 billion. “No one knew where the bottom would be. It makes sense that people used derivative strategies to protect themselves.”
Market timing has been a challenge this year for individuals and institutions alike. Bank of America Corp. said last month that its trading clients were net sellers of stocks for eight straight weeks, the longest stretch in five years. Mutual funds have seen near-record outflows in 2016.
Bulls are kidding themselves if they think volatility isn’t coming back, according to Richard Turnill, global chief investment strategist at BlackRock Inc., the largest ETF provider. Swings in the market were repressed for years by the Federal Reserve’s quantitative-easing program of bond purchases, and now that it’s over periods of placidity will prove temporary, he wrote in a March 31 blog post.
When the Fed concluded its first round of quantitative easing in March 2010, the VIX more than doubled over the next two months, reaching a peak of 46. When the second round of QE ended in June 2011, the volatility gauge was near 16 and then jumped, averaging about 30 through the third quarter.
“The future path of monetary policy remains uncertain, and tail risks remain,” Turnill wrote. “I do not expect this calm to last, and I see a return to the higher-volatility regime that was the norm prior to QE.”
Investors have repeatedly been caught on the wrong side of VIX trades, making a pair of mistimed bets in the second half of 2015. During a week-long stretch in August that saw the S&P 500 plunge 11 percent, traders placed $157 million of new money into the three long-VIX ETNs. The benchmark gauge erased that entire loss over the following 15 weeks.
In the three weeks leading up to a three-month S&P 500 high reached on Nov. 3, the ETNs captured about $600 million. The equity gauge lost more than 4 percent in just 10 days.
ETNs can carry additional risks which many investors aren’t aware of, according to Sosnick. They’re not meant to be held on a long-term basis because costs associated with holding the underlying index or benchmark can accumulate, more than offsetting potential return.
“There are so many layers of derivatives underlying these trades, of course there’s going to be decay,” said Sosnick. “People don’t always appreciate how they’re layering options upon options in trades like that. Investing like that is never easy.”
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* (All times New York)
* Economic Data
* 9:45am: ISM New York, March, est. 54.1(prior 53.6)
* 10:00am: Labor Market Conditions Index Change, March
(prior -2.4)
* 10:00am: Factory Orders, Feb., est. -1.8% (prior 1.6%)
* Factory Orders Ex Trans, Feb., est. -0.5% (prior
-0.2%)
* Durable Goods Orders, Feb. F, est. -2.8% (prior
-2.8%)
* Durables Ex Transportation, Feb. F, est. -1.0%
(prior -1%)
* Cap Goods Orders Non-def Ex Air, Feb F (prior -1.8%)
* Cap Goods Ship Non-def Ex Air, Feb F (prior -1.1%)
* Central Banks
* 9:30am: Fed’s Rosengren speaks in Boston
* 7:00pm: Fed’s Kashkari speaks
* Supply
* 11:00am: U.S. to announce plans for auction of 4W bills
* 11:30am: U.S. to sell $28b 3M bills, $24b 6M bills
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Neel Kashkari, the new president of the Federal Reserve Bank of Minneapolis, is positioning himself as an unlikely regulatory threat to the nation’s biggest banks.
Six weeks after an attention-grabbing speech in Washington in which he called on government to consider breaking up big banks like J.P. Morgan Chase & Co. and Citigroup Inc., he kicks off a series of public meetings Monday in Minneapolis to bolster his case that rules designed to prevent taxpayer rescues of the financial system don’t go far enough.
He also intends to deliver a proposal to Congress by year-end for how they should strengthen those rules.
Like many others who have argued that banks might be dismantled, this former investment banker and Treasury Department official is finding several obstacles in his way, including many of his new colleagues.
Although it’s not necessary and Fed communication is often uncoordinated, Fed presidents sometimes circulate speeches with the board in advance of their public remarks. That Mr. Kashkari gave colleagues less than 24 hours’ notice on a controversial subject—his first public utterances on the subject as a Fed official—left some colleagues feeling caught off guard.
Barely a month into his new job, Mr. Kashkari announced his bank was launching a year-long plan to ensure big financial firms won’t need taxpayers to rescue them in another crisis.
Former Fed Vice Chairman Donald Kohn, who is now a senior fellow at the Brookings Institution, said the Minneapolis Fed president hasn’t proved his underlying premise—that regulators won’t be willing or able to wind down failing firms in a widespread crisis.
“He needs to get informed on this whole process and what the strong and weak points of it are,” Mr. Kohn said. “He needs to think about what’s already happening to a number of these banks that are repositioning themselves…under the impetus of higher capital requirements.”
On Wall Street, some bankers were stunned 42-year-old Mr. Kashkari would go after the industry that had once employed him and to which he still has close ties. Before accepting the Fed job late last year, Mr. Kashkari sought out several senior Wall Street executives, including J.P. Morgan Chase Chairman and Chief Executive James Dimon, with whom he had wide-ranging conversations that included his next potential career move, according to people familiar with the conversations.
Some executives interpreted the meetings as informal job interviews, the people said. A spokesman for the Minneapolis Fed chief confirmed that Mr. Kashkari met with people on Wall Street but said he never sought employment at a Wall Street bank following his failed run for the California governorship in 2014.
Mr. Kashkari gained prominence during the financial crisis when then-Treasury Secretary Henry Paulson, whom he had followed into public service from Goldman Sachs Group Inc., tasked him with administering the Troubled Asset Relief Program, or TARP, a program to buy assets and equity from banks as part of the 2008 financial bailout. Before TARP, Mr. Kashkari spent four years in investment banking, helping entrepreneurs raise capital out of Goldman’s San Francisco office. After Treasury, he spent four years at Pacific Investment Management Co., which hired Mr. Kashkari in 2009 to help turn the bond-fund giant into a player in equity funds.
Mr. Kashkari is undeterred by the criticism. “The Wall Street critics and the lobbyists are reduced to trying to criticize the process or criticize my intentions because they can’t argue with me on the substance,” he said.
If Congress reviews his proposal and decides not to pursue legislation that would toughen rules for banks, Mr. Kashkari said, “that’s fine. What I’m against is Congress being left with a false sense of security that this can’t happen again.”
He acknowledged he has gotten a “wide range of reactions”—including disagreement—from across the Fed system. “And that’s OK,” he said. “The reason we have a distributed central bank is we’re supposed to have a diverse set of opinions.”
One apparent response came from Fed Chairwoman Janet Yellen. In a March 16 news conference, she said, “we’ve been working at this for a number of years, and I believe we have made very substantial progress,” when asked about the public perception that financial change has so far been ineffective. Many listeners said they took those remarks as a rebuttal to Mr. Kashkari.
While some have criticized Mr. Kashkari for wading into an area in which he technically has no authority—regulatory policy is set by the Federal Reserve Board in Washington, not by reserve-bank presidents—others said it is entirely appropriate, noting he isn’t the first regional president to criticize big banks or the way they are regulated.
“I’m very supportive of him in this regard,” said Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corp. and former Kansas City Fed president, who has pushed for higher capital requirements for big banks.
Gary Stern, the president of the Minneapolis Fed from 1985 to 2009, said Mr. Kashkari’s background makes him a “natural fit” for working on the “too big to fail” issue, which has been a focus of the bank’s research department for decades. As for his speech, Mr. Stern said, “I don’t think it gives adequate attention to Dodd-Frank,” referring to the 2010 law that overhauled financial regulations.
Although Mr. Kashkari didn’t discuss too big to fail during his interviews with the Minneapolis Fed board of directors, which hired him, his interest in the subject wasn’t a surprise, said MayKao Hang, the board’s chairwoman. He had given a speech in 2011 questioning the effectiveness of Dodd-Frank in a major crisis.
Critics of Wall Street and the Fed welcomed the remarks, though others criticized them as being too political in tone to have the imprimatur of the Fed.
“I think, frankly, Mr. Kashkari is acting still more like the candidate for governor he was in California than a Federal Reserve official,” former Rep. Barney Frank (D., Mass.), the namesake of the regulatory overhaul, said on PBS NewsHour March 24.
Mr. Kashkari said he isn’t interested in another election. “If I had any aspiration to run for office again, this is not what I would be doing,” he said, adding that Wall Street had been a big donor base during his failed gubernatorial run.
During his interviews for the Minneapolis job, Mr. Kashkari mentioned that he wanted the bank to take on issues of national importance and impressed the directors with his straightforward style.
“The fact that he has and does communicate differently than I think some other people is a real strength,” Ms. Hang said.
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