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The BAN Report: Moody's Slams Banks / Inflation Eases / RTO for Federal Workers / RIP Pac-12 / Wasteful Us-8/10/23

Moody’s Slams Banks

Earlier this week, Moody’s downgraded 10 regional banks, placed another six under review, and gave negative outlooks to another eleven.  

Rising funding costs and declining income metrics will erode profitability, the first buffer against losses. US banks’ Q2 results broadly show a rapid rise in the cost of funding. Although the general drain on deposit funding caused by quantitative tightening (QT) moderated in Q2, there remains a significant risk that systemwide deposits will resume their decline in coming quarters. Most banks' deposits were flat or down only modestly, but the mix worsened, with non-interest-bearing deposits declining and banks paying more for deposits. The resulting drop in net interest income and net interest margins eroded profitability and, thus, the ability to replenish capital internally. Banks have reduced loan growth to preserve capital, but this will slow the shift of balance sheets toward higher yielding assets, even as funding costs rise and banks deal with a yield curve inversion.


Most regional banks have comparatively low regulatory capital versus the largest US banks and global peers. In the current high-rate environment, this leaves some banks with sizable unrealized economic losses that are not reflected in their regulatory capital ratios vulnerable to a loss of investor confidence. Further, we expect a US recession in early 2024 will worsen banks’ asset quality and increase the potential for capital erosion. A proposed increase in regulatory capital requirements for all banks with assets above $100 billion is credit positive, but in the near term will come with increased regulatory costs and may entail business model changes that strain some banks' profitability. Further, regulatory tailoring that sets lower capital and liquidity requirements for banks with less than $100 billion in assets is credit negative, and weaker regulations can promote excessive risk-taking at some banks.


Asset risk is rising, in particular for small and mid-size banks with large CRE exposures. Asset quality metrics remain solid across most consumer and commercial lending segments, but have begun to deteriorate and have been unsustainably strong compared with historical pre-pandemic levels. Elevated CRE exposures are a key risk given sustained high interest rates, structural declines in office demand due to remote work, and a reduction in the availability of CRE credit.


Stonecastle Partners CEO Josh Siegel said the following: “The downgrades are timely - regionals have been under competitive pressure for some time.  If you’re a regional, how do you compete except on price?  They’re too big to be tightly connected to their communities, so they can’t be doing it on deep relationships, and they are not large enough to compete with the money center banks who can dictate price.  I’ve heard this from mid-market corporate borrowers, who say they get their best borrowing rates from regional banks.  The downgrade reflects the existing reality.”













With respect to CRE, concentration levels are certainly higher amongst the smaller institutions. Moody’s also noted that “one notable feature of US banks’ Q2 earnings was that several larger banks’ earnings releases included the impact of higher CRE provisions while those of smaller banks with higher CRE concentrations did not.” Nevertheless, the performance of regional banks and CRE for that matter is fairly correlated with the general economy. Nearly every issue raised in the report is an issue faced by large banks as well.

Inflation Eases

July’s CPI reading shows inflation continuing to ease, according to the Labor Department today.

The consumer-price index, a measure of goods and services prices across the economy, rose 3.2% in July from a year earlier, up from 3% in the year through June, the Labor Department said Thursday. So-called core prices, which exclude volatile food and energy categories, rose by 4.7% in July from a year earlier, a slight cooling from June’s 4.8% increase.

The monthly figures, however, offered a more encouraging picture of current price trends. The CPI rose a mild 0.2% in July, same as in June. Even better, the core CPI also increased just 0.2% in both months, suggesting inflation isn’t starting to resurge. Fed officials focus on core inflation because they see it as a better predictor of future inflation than the overall inflation rate.

The pickup in the annual CPI reading was influenced by what happened during June and July of 2022, which serve as the basis for comparison, economists said. The annual rate of inflation is likely not to slow much more this year and could accelerate into early 2024 because of so-called base effects, they added.

The core CPI, in particular, adds to recent data that calls into question whether the central bank will need to raise rates again this year, as most officials had projected in June.

The new numbers lowered the three-month annualized rate of core inflation to 3.1%, the lowest such reading in two years, from 5% in May.

“My God, that’s incredible,” said Laurence Meyer, a former Fed governor. “There’s absolutely no question that core inflation has turned the corner faster” than the Fed anticipated.

Currently, only fuel oil and utility (piped) gas service showed significant inflation at 3% and 2.0% respectively, but fuel oil is down 26.5% over the last 12 months while utility (piped) gas service is down 13.7%. While this news is encouraging, we still think the Fed will continue to keep rates elevated until inflation is behind, especially when the GDP and unemployment numbers continue to outperform expectations.

RTO for Federal Workers

The Biden Administration is urging its cabinet officials to bring its workers back to the office this fall, bringing relief to office buildings and downtowns in many major cities.

“As we look towards the fall, and with the end of the COVID-19 public health emergency, your agencies will be implementing increases in the amount of in-person work for your team,” White House Chief of Staff Jeff Zients wrote to Cabinet officials on Friday. “This is a priority of the President — and I am looking to each of you to aggressively execute this shift in September and October.”

Friday’s missive, first reported by Axios, brought renewed attention to a post-pandemic struggle for many private employers that has drawn the Biden administration into an increasingly partisan debate over government workers’ performance — and the potential waste of taxpayer money.

“We are returning to in-person work because it is critical to the well-being of our teams and will enable us to deliver better results for the American people,” he wrote. “These changes will allow us to harness the benefits of enhanced flexibilities that we experienced during the pandemic, while ensuring we have the in-person time we need to build a strong culture, trust, and interpersonal connections.”

Zients added that working in person is critical for newer staff members and pointed out how the White House, which has been operating in person for the past two years and hosting large events like holiday parties without incident, has embraced a policy “which has allowed us to work more nimbly and effectively as a team and with the aim of serving you and your agencies better.”

The message comes as pressure is growing not just from Republicans on Capitol Hill to return federal workers to the office, but also from D.C. Mayor Muriel E. Bowser (D) and city leaders who are desperate to attract more workers and residents to downtown. Calls for a robust return to the office have accelerated in recent weeks from former New York Mayor Mike Bloomberg (D) and the nonpartisan Government Accountability Office, which in July released sobering statistics showing vacant offices at many Washington headquarters.

GAO, Congress’s research arm, reported that many agency headquarters remain vastly underused as federal workers stay home, costing the government millions of dollars a month in rent. GAO found that 17 of 24 large agencies that occupy most of the federal real estate footprint were filled at just 25 percent capacity or less during three separate weeks from January to March of this year.


“Underutilized office space has financial and environmental costs,” the report found.

From reading the comments in the Washington Post, this change is not popular. The federal government though has more leverage on its employees than most employers. Downtowns should begin to feel more vibrant this fall as others follow suit.


RIP Pac-12

With only 4 teams remaining, the collapse of the Pac-12 is complete. The Athletic had a great story on how the conference went from one of the strongest to its demise in just 12 years.

Upon the retirement of longtime Pac-10 commissioner Tom Hansen in 2009, Pac-10 presidents looked outside their industry and hired Scott, then CEO of the Women’s Tennis Association. Their mandate: Raise the profile of a proud conference long hindered by its time zone and an outdated TV contract (remember Fox Sports Net?).

Almost immediately, he wowed them. First, with an audacious and nearly successful attempt to lure Big 12 powers Texas and Oklahoma out West and form a 16-team conference, ultimately adding Colorado and Utah to become the Pac-12. Then, he stunned the industry by luring ESPN and Fox into a bidding war with Comcast that quadruped the league’s previous annual TV revenue.

From that point forward, the presidents, led by Scott’s principal champion, Arizona State’s Michael Crow, gave him anything he wanted — and what he wanted most was to launch a media company that he would run for a princely salary (eventually $5.3 million).

Scott’s ill-advised strategy to launch the Pac-12 Networks without a proven media partner like ESPN has been well-documented. The bizarre seven-channel model struggled to gain distribution and never came close to delivering its projected revenue figures. It became an albatross from which league members could never escape.

But it wasn’t just Scott who screwed this up. As The Athletic recounted last year, the league in 2015 had a deal in hand to finally get the network on DirecTV — and the presidents, led by Crow, rejected it. Were this the SEC, they would not have been allowed back at work the next day. But that’s not how they do things out west.

The fall of the Pac-12 is a good business lesson that an entity can go from riches to extinction in a short time if they misplay their cards. Universities need to squeeze every dollar out of their athletic programs due to their bloated budgets.

Wasteful Us

In order to fund out of control spending, America’s universities have been hiking tuition and saddling their students with crippling debt, according to a damning study by the Wall Street Journal.

The University of Kentucky upgraded its campus to the tune of $805,000 a day for more than a decade. Its freshmen, who come from one of America’s poorest states, paid an average $18,693 to attend in 2021-22. 

Pennsylvania State University spent so much money that it now has a budget crisis—even though it’s among the most expensive public universities in the U.S. 

The University of Oklahoma hit students with some of the biggest tuition increases, while spending millions on projects including acquiring and renovating a 32,000-square-foot Italian monastery for its study-abroad program.

The spending is inextricably tied to the nation’s $1.6 trillion federal student debt crisis. Colleges have paid for their sprees in part by raising tuition prices, leaving many students with few options but to take on more debt. That means student loans served as easy financing for university projects.

“Students do not have the resources right now to continue to foot the bill for all of the things that the university wants to do,” said Crispin South, a 2023 Oklahoma graduate. “You can’t just continue to raise revenue by turning to students.”

It has long been clear to American families that the cost of college has gone up, even at public schools designed to be affordable for state residents. To get at the root cause, The Wall Street Journal examined financial statements since 2002 from 50 universities known as flagships, typically the oldest public school in each state, and adjusted for inflation. 

At the median flagship university, spending rose 38% between 2002 and 2022. 

Only one school in the Journal’s analysis—the University of Idaho—spent less. 

The schools paid for it in part by pulling in tuition dollars. The median flagship received more than double the revenue from undergraduate and graduate tuition and fees it did 20 years prior. Even accounting for enrollment gains, that amounted to a 64% price increase for the average student, far outpacing the growth in most big household expenses. 

The spending is mind-boggling. Salaries and benefits are up by 40% since 2002. Oklahoma spent $14.3 million to buy and renovate a monastery in Italy for a study-abroad program. If the Federal Government provides the vast majority of student loans, why don’t they force the Universities to cap their tuition increases in order to participate?   

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