Q2's Gita Thollesson joins Alex Habet for a mid-year check-in to see what Q2 PrecisionLender data can tell us about how banks are faring in this volatile market.
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[July 27, 2023, Webinar] State of Commercial Banking Mid-Year Update
[Report] State of Commercial Banking January 2023 Market Analysis
[Webinar Replay] State of Commercial Banking January 2023 Market Analysis
Transcript
Alex Habet
Hi, and welcome to The Purposeful Banker, the leading commercial banking podcast, brought to you by Q2 PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm your host, Alex Habet.
So of all the big topics that we talk about to the best bankers, so to speak, there's one particular area that tends to be bigger among peers in terms of interest. Mainly, I think that goes for obvious reasons. A lot of the action in our space, whether it's actions from our government or changes in policies at the corporate level, a lot of those things take time to manifest themselves in the data and the evidence of the impacts and the outcomes that they promised. So, as we do periodically, we open our doors to what our information is telling us about the market because we have one of the earliest indicators of a lot of the big things that are happening out there manifesting themselves into the data. I think we do a pretty good job of getting the message out there, mainly thanks to our next guest.
Now, of course, we talk on a monthly basis through the monthly market updates from Anna-Fay's blog posts, but every six months or so, we get to check in with Gita Thollesson for her update on what's going on at a much more big-picture level, and today is that day. So Gita, welcome back to the show. Thank you for gracing us again ahead of another exciting presentation coming up.
Gita Thollesson
My pleasure. It's good to be here with you, Alex.
Alex Habet
Yeah. So we got this mid-year, I guess it's becoming a regular staple. I mean, people couldn't resist waiting ... basically 12 months was too long, I think, for these updates, so they want them more frequently. So this is awesome that you get to do this again. The presentation is on July 27th.
Gita Thollesson
That's right.
Alex Habet
2 p.m. Eastern Time. I just wanted to mention that up front. One of the cool things is I get to learn live in the moment when we're recording together the show about some of the things that are coming up, but I know that you're going to want to save a lot of the interesting parts of the presentation for the actual event. But one of the things that, just like we did last time, Gita, was we anchored on the past presentation as a jumping-off point to set the stage for the next one.
But before I do that, obviously a big part of the story is generated out of the dataset. Last time we went into detail around the makeup of the data, how it's collected, et cetera. I don't know if we need to rehash that today, but has anything materially changed, have any new dimensions been added, or we're just continuing down the same framework now?
Gita Thollesson
So it's the same framework. The analysis is based largely on our own proprietary data. What's changed, perhaps, even since January is just the scope of that data. We've picked up some additional banks. We've got even more banks and credit unions supplying data to us. So it's growing, but it's the same basic proprietary data. It's commercial loans, deposits, and other fee-based business from banks across the country that really run the gamut from the smallest community banks to top 10 institutions. So really the world's best source of market intel around commercial banks. And then we supplement that with other public data, Fed data, FDIC, to get more of a high-level view of what's going on in the overall banking space.
Alex Habet
I suspect, just out of curiosity, when you start to connect these third-party sets of information, that it's validating in fact, from a different point of view, the same perspective that we're seeing even earlier, I think, than what some of those sources are publishing.
Gita Thollesson
Right, exactly. Validating, but then sometimes contradicting. So there are cases where there might be some perceptions that are shared via, let's say the FDIC or the Fed survey on banking practices, where people almost tell you what they think you want to hear, and then you look at the data and it doesn't quite pan out the way that folks expect. So some interesting contrast there, as well as confirmation.
Alex Habet
Well, that's interesting to hear. So let's go back again to January, which is the last time you presented broadly this talk. Last time, there were three key takeaways that were highlighted. The first one was the economic outlook for 2023 is uncertain. The second one was that banks are bracing for a downturn but not yet seeing the deterioration. And the third was the focus on deposits is renewed amid a competitive lending climate. So let's forget about those second two for a second. Let's focus on the first one because 50% of 2023 is now behind us. I just want to get your reaction. Are we still dealing with more uncertainty than certainty at this point?
Gita Thollesson
No. I think the picture has become more clear as time has progressed. The reason that we said at that time that it was uncertain was that there were a lot of mixed signals. So if you go back to say, mid-year '22, we were coming off of a period where we had two consecutive quarters of negative GDP growth, and then we had an inverted yield curve. Those are tell-tale signs of a recession. So by really the middle of last year, we started to hear rumblings about an economic downturn is coming. And then when the Fed started to raise rates in '22, and then just continued those increases, if anything, the sentiment was that if we weren't already headed for a recession, the Fed is now pushing us toward a recession. They're going to fast track it by virtue of these incessant rate increases, which are just raising borrowing costs and creating a lot of stress in the economy.
So the feeling at that point, really late '22 into early '23, was that a recession was looking pretty likely. And the question, it wasn't a matter of whether, it was a matter of when. But at the same time, even while we had those signals, there were also some positive signals that are really not typical of a recession. So we had historically low unemployment, for example, rising industrial production. I mean things that really don't typically scream recession. And that's the reason for saying that there was a lot of uncertainty back then.
Now, what's happened since then is that, so after those two negative quarters in the first half of '22, we haven't had a negative quarter since. So those tell-tale signs of recession haven't really come to fruition. But at the same time, the sentiment is still out there that things are headed south, a recession is coming, or at least some slowdown in the economy is coming. That said, first quarter GDP, the third estimate was revised upward. It's now 2% for the first quarter. Unemployment is still a little north of three and a half percent, so still some pretty positive signs out there. So definitely a clearer picture than where we were at the beginning of the year that it's not looking quite as dire as things were starting to feel. But, yeah, so I'd say more certainty, but still definitely sentiment toward a slowing economy, although it hasn't yet come to fruition.
Alex Habet
Isn't it funny how the sentiment just keeps getting kicked down the road, and we're almost inoculated to it at this point? It's just business as usual to have a negative sentiment on the economy when we're seeing ... I guess, what was the most surprising recent data point that you saw and you're like, "Wow, I can't believe this was this much better?" Which one?
Gita Thollesson
Well, the Fed survey, which basically asked what are you anticipating in terms of loan demand and credit tightening and raising pricing. And I was thinking that after so many positive signals, that the sentiment would start to turn at least a little bit less negative, but it's actually continued that upward trajectory toward more and more, with each passing quarter, it's that much more negative. More banks are saying that they're being conservative. More banks are saying they're raising pricing. More banks are saying that loan demand is suffering or will suffer across the board. So it's not turning positive at all. I think it is just kicking the can down the road in effect.
Alex Habet
Also, there's been three noteworthy banks that are no longer independently operating. This is especially since the last time we chatted. Wow, that's how not long ago that was. But I'm interested, did you see any direct impact of those events manifest themselves in the data in any concrete way, or is it just background noise more than anything?
Gita Thollesson
Yeah, no, absolutely. In fact, the catalyst for those failures really ties back into what we were talking about last time in January when we talked about the drive for deposits. So really what happened starting mid-year '22 in effect, was we started to see commercial deposits start to exit the banking system. And at that time, really by the fall of '22, people were saying, "Yeah, we've got to start raising deposit rates. We have to start really paying up for these deposits." It was basically a situation where banks were coming off of two years of excess liquidity where they had more deposits than they knew what to do with. So there was some hesitation in raising deposit pricing. And by really the fall of last year, there was a recognition that this was important and that these deposits were super lucrative, especially in the rising rate environment, and we have to pay up for them.
So we were anticipating much more focus on raising deposits, but in effect, the outflow of deposits is what really sparked those three failures. So we were in a situation where deposits started to bleed out and the banks really didn't have the capital to cover those deposits. And then you layer in social media and Twitter, and a single tweet that went viral basically caused a shutdown within about 24 hours. So it was really the same drivers that we were talking about in January, but really at a much more elevated level, where now, as opposed to just being an issue that banks had to deal with, that we've got to stop this outflow of deposits and maybe look at raising rates, it was much more, this is catastrophic now, this is at the point where if we don't do something mighty quick, we're really at risk of insolvency.
So yeah, it has stepped up the focus, and we definitely see that in the data. So we started to see in '22 some increases in commercial deposit pricing, but by this year, I mean it's off the charts in terms of just how much banks are paying up for those accounts, especially the larger accounts, the uninsured large deposit relationships. We're really paying through the roof in terms of just trying to keep those deposits in-house.
Alex Habet
Yeah. Specific to just going back for a moment to the crisis around the three banks, do you think that phase of the crisis is over, or do you think more of these could theoretically pop up?
Gita Thollesson
Well, so those three, they really, first of all, don't epitomize the banking industry as a whole. I know that a lot of larger banks have really gotten a bad rap for what happened with those three. But one of the things that we've done in this report is we've taken a really close look at those three relative to the industry as a whole. And while there are some factors, I know you had actually spoken about one of these at one of your recent podcasts, or one of the podcasts that followed those failures. You and, I believe, Dallas had talked about how the balance sheet had shifted toward much more treasuries and other securities, not really high risk, but not super liquid either. But when you look at some of those factors that impacted the overall banking market, but then look specifically at those three banks relative to everyone else, it really is quite a stark contrast.
So those three banks had a much higher percentage of their assets in those securities than the industry as a whole. Those three banks had a much higher concentration in commercial relationships, which also translates into uninsured deposits. So it was primarily commercial customers. The deposit relationships, average balances were over $250,000. They weren't insured. Very, very low percentage of FDIC insurance. So the bread and butter banks are not really dealing with that type of issue that caused those failures.
Now, I think separate from what the government has done to reinstate confidence in the banking system, when you really start to look at what sparked those failures, it's not really typical of most commercial banks. So, probably not. You might have one or two additional failures if the situation warrants it in terms of take some banks that may have a focus in commercial. I mean, we definitely saw some outflow of deposits from uneducated depositors that just didn't realize that their bank was actually quite safe. So I think there was some gut reaction to what had happened with those three banks. But no, not really anticipating a repeat of what happened in March. That's unlikely at this point.
Alex Habet
Well, that's reassuring. Thank you, Gita. I feel better now.
Gita Thollesson
Hope I'm right. We'll see, but yeah.
Alex Habet
So let's step back to the other two takeaways from last time. Again, I don't want you to spoil or alert anything new that's coming out, but you cited the Fed survey with the sentiment at the banks. So the bracing is still in high gear, right?
Gita Thollesson
Right.
Alex Habet
And the focus on deposits. I mean, look, from the perspective of this show, that kind of content is cranked to 11 for us, if you get that reference. But it's still top of mind. I mean, anything interesting to update the audience on the world of deposits? I mean, what are balances looking like? I'd love to learn something like that.
Gita Thollesson
So balances for the industry as a whole pretty much fell off a cliff in '23. So when you look at the Fed H8 data, dramatic declines in overall deposits, which really is twofold. Part of it is that as borrowing costs have risen so much for corporate borrowers as well as for consumers, a lot of borrowers would rather tap into their own deposit reserves than tap the bank loan market. So it's getting very expensive to borrow at this point. But then the other part of it in terms of deposits exiting the system is just chasing yield. So it's not so much when you look at the primary operating account, so the ECR deposits, which corporations maintained to help pay for their treasury management services. So those deposits are not the ones that are really exiting. It's the excess deposits where companies are essentially looking for yield.
You can go out and buy a treasury and make more than what a bank can really afford to pay at this point. So some of those deposits are still at risk and they're still exiting, but the rates that banks are paying now have risen just so much that it really is a much more compelling proposition to just keep your money where it is, at least for corporations. Now, the consumer side is different, but for corporate borrowers, yeah, I mean, the largest accounts are now getting close to 4% on just interest-bearing checking and money market. So yeah, dramatically increased.
Alex Habet
Alright. Well, again, I want to thank you, Gita, for helping us anchor from last time as we think about the next six months. Is there anything else, any parting words you have for the audience ahead of 2024?
Gita Thollesson
No, just tune into the webinar and you'll see a lot more data, a lot of our proprietary data that we'll share, including the key risk metrics by sector. So, looking forward to sharing that intel.
Alex Habet
Alright. Well, thank you again for coming on. Remember, tune in Thursday, July 27th at 2 p.m. Eastern, 1 p.m. Central to catch the full Gita show. Gita, thanks again.
Gita Thollesson
My pleasure.
Alex Habet
That's it for this week's episode of The Purposeful Banker. If you want to catch more episodes, please subscribe to the show wherever you like to listen to podcasts, including Apple, Spotify, Stitcher, and iHeartRadio. You can also catch the show on YouTube. Don't forget to subscribe and like the video. And if you have a minute to spare, let us know what you think in the comments. You can head over to q2.com to learn more about the company behind the content. Until next time, this is Alex Habet, and you've been listening to The Purposeful Banker.
