Something’s going on beneath the surface of U.S. banking, and it’s more intricate than it appears. Even as these financial institutions seem to be on the mend following the collapse of Silicon Valley Bank four months ago, they’re leaning heavily on government funding.
A healthy façade belies a pressing concern: despite robust share prices and positive Q2 earnings, regional banks can’t kick their reliance on Uncle Sam’s aid.
The crutch of federal support
The critical lifeline for these U.S. banks comes from the Federal Home Loan Banks (FHLBs) – a cluster of 11 government-sponsored regional lenders. These establishments are no small fry; if they hit the skids, it’s likely Washington would swoop in for the rescue.
Data from the FHLB Office of Finance revealed that U.S. banks and credit unions had loans totaling $880bn outstanding at June’s close, courtesy of these lenders.
In comparison to the record $1tn of FHLB borrowing seen at Q1’s end, this might seem a relief. But let’s not celebrate just yet. When compared with 2021’s end, this figure represents an increase exceeding 150%.
The San Francisco FHLB’s chief, Teresa Bazemore, stated their role had been to stabilize the system, suggesting that this level of support will persist as long as interest rates do.
However, the network has faced criticism for allegedly fostering risk-taking due to government sponsorship. This scrutiny has intensified following the collapse of SVB and Signature Bank, both of which were borrowers from the network.
Unsettling reliance despite the appearance of strength
U.S. banks aren’t mandated to disclose the extent of their borrowing from FHLBs to their investors. Nevertheless, during the recent earnings season, some banks flaunted their ability to repay FHLB loans as a symbol of fiscal strength.
Take, for example, Western Alliance. Its CEO, Kenneth Vecchione, proudly highlighted their successful reduction of reliance on high-cost FHLB borrowings. A similar success story comes from Citizens Financial, which trimmed its FHLB borrowing by nearly 60% in the Q2 period.
Despite such examples, a plethora of banks, some of which experienced a share price plummet earlier this year, have managed to reduce their dependence on this funding by only a smidgeon.
Another lending lifeline came from the Federal Reserve, which launched a loan program allowing banks to swap top-rated long-term securities for a 12-month cash loan. Usage of this facility continues to surge, hitting a new record high with a total borrowed sum of $105bn.
What’s puzzling is the dichotomy between the continuing reliance on these financial supports and the outwardly healthier state of the banking industry.
CFRA Research bank analyst Alexander Yokum expressed surprise that balances of the Fed’s special assistance program had not decreased despite the industry’s stabilization.
Take Comerica as an example, with $13.5bn in FHLB advances at Q2’s end. That’s 15% of Comerica’s overall assets, a figure that stands at triple the average of its peers. This bank has pledged 98% of its securities holdings to other lenders, including the Fed.
The oddity of it all becomes even more apparent when one considers Comerica’s stock has bounced back 65% from its early May low. During a call with analysts, Comerica’s chief proclaimed the bank’s “strong liquidity position” and revealed they had repaid “maturing FHLB advances.”
