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Regional Bank Update

When any turmoil arises, as it has in the banking sector this year, we begin our analysis with a deep risk assessment. Our conclusion: While we are not…

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When any turmoil arises, as it has in the banking sector this year, we begin our analysis with a deep risk assessment. Our conclusion: While we are not actively increasing the overall exposure to banks in our U.S. value equity portfolios, we continue to use the market’s short-term volatility as an opportunity to potentially upgrade the quality of the portfolios’ holdings.

Entering the Year

Banks have been well represented across the value indices. Going into the start of the year, they made up about 18% of the Russell 2000 Value Index, 11% of the Russell 2500 Value Index, and 6% of the Russell Midcap Value Index.

But the composition changes between the size of the indices. The midcap value index tracks about 30 super regionals. But smaller regional and community banks—more than 300 of them—dominate the small-cap value index.

The sheer number of banks in the small-cap value index tells us that U.S. banking is still a regional, relationship-based network serving local communities. And while consolidation and roll-ups are likely over time, we believe regional banking will still have a role to play. In other words, the United States is unlikely to look like Canada or Europe, with only a few dominant players. The U.S. economy is much more heterogeneous than the rest of the world, and smaller banks play a role in supporting the diverse local economies in which they reside.

As we started 2023, we were underweight the banking subsector of financials across our Small Cap Value, Small-Mid Cap Value, and Mid Cap Value strategies. This underweight was most pronounced in our Small Cap Value strategy, which had a 15% allocation to banking vs. 18% in the Russell 2000 Value Index.

While our underweight positioning has contributed to relative performance, we by no means were predicting a run on several midsize lenders. So why the underweight?

While earnings pressure and regulation could weigh on returns, we believe most banks should be well equipped to exceed their costs of capital and live to see another day or cycle.

We entered the year cautious about banks because the drivers of their fundamentals didn’t look overly attractive to us. What really drives banks’ share price is loan growth, net interest margin (NIM, which is the difference between deposits rates and other capital costs and the interest rates the bank gets on loans), and credit quality.

As we entered 2023, the first of those fundamentals—loan growth—was still healthy. However, banks took in enormous sums of deposits during the pandemic (due to excess stimulus and the surge in M2[1]), and we believed loan growth would not be able to keep pace. As their deposits grew, some banks responded by purchasing long-dated U.S. Treasurys as their loan-to-deposit ratios were out of whack. Unfortunately, some failed to properly hedge their interest-rate exposure and were forced to mark these assets down as nervous depositors sought liquidity.

Just as important, we believed NIM expansion was peaking or had limited upside—in part because there is now much more competition for deposits. After a decade of not considering an alternative to a checking account rate, investors and savers have more attractive options in money markets or short-dated fixed income. We don’t believe banks will lose all their deposits; they will likely just have to pay more to retain them.

Lastly, credit quality has been pristine to this point, and only has one direction to go if we are entering a period of economic weakness.

So, we entered the year underweight banking, and remain underweight today.

Where Are We Today? 

Immediately after JP Morgan Chase rescued First Republic Bank (FRC), market skepticism shifted to the next-most-exposed banks based on deposit risk and liquidity concerns (such as PacWest). Since the U.S. Federal Reserve (Fed) and Treasury were willing to take FRC into receivership and effectively wipe out the equity, short sellers and other market participants have recently bet heavily against other banks that look similar to those that failed.

As patient, long-term value investors, however, we don’t believe all regional and smaller banks should be tarnished. Yes, some of these banks in the crosshairs have similar profiles, but in general, we believe regional banks’ troubles are earnings issues rather than liquidity issues. And from a longer-term perspective, while earnings pressure and regulation could weigh on returns, we believe most banks should be well equipped to exceed their costs of capital and live to see another day or cycle.

And that’s what we’ve heard from the banks we own in our portfolios. The majority have reported first-quarter results—some have shown deposits down by the low single digits, while others actually have witnessed deposit growth. The first quarter was all about the vector of deposits, and for the banks we own, so far so good. As of the week ended in May 10, the latest H.8 data from the Fed (which presents an estimate of weekly aggregate balance sheets for all U.S. commercial banks) indicates that the pace of deposit outflows seems to have stabilized, although it is still falling, since the turmoil began in March. In fact, most of last week’s outflows were concentrated in large banks, not the smaller regionals. Now, that refers to absolute deposit dollars; however, the mix of deposits is clearly changing, with non-interest-bearing deposits coming down as deposits move to higher-yielding alternatives within banks, such as CDs or money markets.

This should continue to pressure NIMs. In terms of their outlook, all of the banks we heard from assumed that the Fed would raise rates in May, further impacting NIM compression in the second quarter (albeit not as much as we have already experienced). But the banks are expecting that situation to stabilize as the Fed is predicted to pause in the second half of the year.

It is important to remember that in the bank universe, not all commercial real estate is created equal.

In terms of loan growth, thus far we are still seeing positive growth. Still, the pipeline has been shrinking over the last several quarters and will likely continue to shrink. Fed Chairman Jerome Powell explicitly called out the recent turmoil in the regional banks, noting that the banks’ initial reaction would be to cool loan growth and tighten credit lending standards, which in turn should help fuel the Fed’s mission of slowing the economy. This pullback was all but confirmed in the recent release of the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) data, which showed waning demand and tighter underwriting standards.

Credit, meanwhile, has been pristine thus far. Many banks have called out their commercial real estate exposures—specifically office space, as it is widely expected that this may be the next shoe to drop from a credit perspective. In addition, banks are tightening in construction, hospitality, and senior housing. But they are getting more granular, looking beyond what percentage of their loan book is allocated to office space and adding some color around their loan-to-value (LTV) ratios, occupancy levels, and debt service coverage ranges.

It is important to remember that in the bank universe, not all commercial real estate is created equal. There are many suburban medical offices in the Sunbelt that are thriving, for example. And thus far, in many places, credit issues remain benign. Banks as a whole are more diversified now than they were during the Global Financial Crisis (GFC), and underwriting standards have improved. It is also worth noting that while small banks have greater exposure to commercial real estate than large banks, much of the market is now owned by insurance companies, private loan funds, or syndicates. Nevertheless, if commercial real estate is the next source of turmoil, we believe it will materialize slowly.

Another area to consider is multifamily, which banks are still loaning into, highlighting the strong rental rates in select markets. In some areas activity is weakening, but in the Southeast activity is still humming as population migration out of the Northeast and West to the Southeast continues.

So far, then, the outlook has been better than expected, but we remain cautious given how quickly the recent turmoil ensued.

Near-Term Outlook

If all goes well, we will soon return to worrying about “normal” things like a recession as opposed to runs on banks.

Regarding valuations, some banks are currently trading below or at tangible book value (TBV), and we believe that is where we will start to see opportunities, as banks typically bottom before a recession and then begin to outperform once a recession hits.

We believe there are likely to be high-quality banks that are unfairly punished.

That’s because one thing banks tell us about the future is provisioning for loan losses, and banks typically start making those provisions (which they are ramping up now) before a slowdown occurs. These provisions impact earnings now but serve as a leading indicator of where we are headed. Banks tend to experience a “credit migration” (where classified loans on their books move to non-performing), but by the time they actually start taking the charge-offs, they have already reserved for them. And that is the time when their earnings headwind typically starts to abate. In our view, that’s when you really want to go on offense, as that’s also the time the Fed is likely cutting rates.

For banks our preferred valuation metric is price to TBV (P/TBV). Small-mid cap banks currently trade at about 1.1x P/TBV. Historically, the average for smaller banks has been 1.5x P/TBV, with the low end of valuation right at TBV (during most cycles, excluding the GFC). So, today, on an earnings basis, we are below long-term averages, but we believe TBV may have a bit more room to compress as we get closer to a possible recession, especially if it is a deeper recession than most are predicting.

One wild card is how the regulatory picture pans out. Clearly, more regulation is likely to occur as a result of the recent turmoil. We believe this will be focused on banks with assets of $100 billion or more. But even small-cap banks below that asset level usually have some additional burden placed on them as well.

So, it is yet to be seen how regulation will impact the profitability of banks. This likely precludes any merger-and-acquisition (M&A) activity until there is more clarity. Federal Deposit Insurance Corporation (FDIC) rates are likely headed higher, depending on the type of lending and deposits, which will vary. All that will factor into the future profitability of banks and what return on their assets they can generate.

Our Strategy

When any turmoil arises, we always start with a deep risk assessment. In this case we started with liquidity, uninsured deposits, deposit concentrations, and commercial real estate exposures, among other metrics.

After re-underwriting the names in our portfolios, we quickly pivoted to looking for opportunities, as we believe there are likely to be high-quality banks that are unfairly punished.

We are seeking top-quality banks trading at discounts to their peer groups and their own trading history. There are also banks that are just now starting to look interesting—ones with top-notch, sticky deposit bases in specific geographies (namely, northern California or the Southeast). We are also starting to identify a few banks that we would not have owned in the past, because they had premium valuations, but are now coming in more in line with the valuation of their peer groups.

These banks’ earnings may be suppressed over the short term, but we are willing to be patient by coming up with conservative valuations that we believe possess limited downsides before starting to nibble.

So, while we are not actively raising the banking weight in our portfolios, we continue to use the market’s short-term volatility as an opportunity to potentially upgrade the quality of the portfolio’s holdings.

Greg Czarnecki is a portfolio specialist for William Blair’s small- to mid-cap value equity strategies. 

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[1] M2 is a measure of the money supply that includes cash, checking deposits, and other types of deposits that are readily convertible to cash, such as certificates of deposit.

The post Regional Bank Update appeared first on William Blair.

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China Auto Sales Jump 55% Year Over Year As Price Cuts Continue To Move NEV Metal

China Auto Sales Jump 55% Year Over Year As Price Cuts Continue To Move NEV Metal

Retail sales of passenger vehicles scorched higher in May,…

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China Auto Sales Jump 55% Year Over Year As Price Cuts Continue To Move NEV Metal

Retail sales of passenger vehicles scorched higher in May, with 1.76 million units sold, according to preliminary data from the China Passenger Car Association released this week. 

The sales figure represents 8% growth from the month prior. As has been the case over the last several years, new energy vehicles continue to grow disproportionately to the rest of the sector, driving sales higher.

Last month 557,000 NEVs were sold, growth of 55% year over year and 6% sequentially, according to a Bloomberg wrap up of the data. 

The sales boost comes as the country slashed prices to move metal throughout the first 5 months of the year. In late May we noted that China's auto industry association was urging automakers to "cool" the hype behind price cuts that were sweeping across the country. 

The price cuts were getting so egregious that the China Association of Automobile Manufacturers went so far as to put out a message on its official WeChat account, stating that "a price war is not a long-term solution". Instead "automakers should work harder on technology and branding," it said at the time.

Recall we wrote in May that most major automakers were slashing prices in China. The move is coming after lifting pandemic controls failed to spur significant demand in China, the Wall Street Journal reported last month. Ford and GM will be joined by BMW and Volkswagen in offering the discounts and promotions on EVs, the report says. 

At the time, Ford was offering $6,000 off its Mustang Mach-E, putting the standard version of its EV at just $31,000. In April, prior to the discounts, only 84 of the vehicles were sold, compared to 1,500 sales in December. There was some pulling forward of demand due to the phasing out of subsidies heading into the new year, and Ford had also cut prices by about 9% in December. 

A spokesperson for Ford called it a "stock clearance" at the time. 

Discounts at Volkswagen ranged from around $2,200 to $7,300 a car. Its electric ID series is seeing price cuts of almost $6,000. The company called the cuts "temporary promotions due to general reluctance among car buyers, the new emissions rule and discounts offered by competitors."

China followed suit, and thus, now we have the sales numbers to prove it...

Tyler Durden Wed, 06/07/2023 - 20:00

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World Bank: Global Economic Growth Expected To Slow To 2008 Levels

World Bank: Global Economic Growth Expected To Slow To 2008 Levels

Authored by Michael Maharrey via SchiffGold.com,

Most people in the mainstream…

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World Bank: Global Economic Growth Expected To Slow To 2008 Levels

Authored by Michael Maharrey via SchiffGold.com,

Most people in the mainstream concede that the economy is heading for a recession, but the consensus seems to be that downturn will be short and shallow. Projections by the World Bank undercut that optimism.

According to the World Bank, global growth in 2023 will slow to the lowest level since the 2008 financial crisis.

In other words, the World Bank is predicting the beginning of Great Recession 2.0.

You might recall that the Great Recession was neither short nor shallow.

In fact, World Bank Group chief economist and senior vice president Indermit Gill said, “The world economy is in a precarious position.”

According to the World Bank’s new Global Economic Prospects report, global growth is projected to decelerate to 2.1% this year, falling from 3.1% in 2022. The bank forecasts a significant slowdown during the last half of this year.

That would match the global growth rate during the 2008 financial crisis.

According to the World Bank, higher interest rates, inflation, and more restrictive credit conditions will drive the economic downturn.

The report forecasts that growth in advanced economies will slow from 2.6% in 2022 to 0.7% this year and remain weak in 2024.

Emerging market economies will feel significant pain from the economic slowdown. Yahoo Finance reported, “Higher interest rates are a problem for emerging markets, which already were reeling from the overlapping shocks of the pandemic and the Russian invasion of Ukraine. They make it harder for those economies to service debt loans denominated in US dollars.”

The World Bank report paints a bleak picture.

The world economy remains hobbled. Besieged by high inflation, tight global financial markets, and record debt levels, many countries are simply growing poorer.”

Absent from the World Bank analysis is any mention of how more than a decade of artificially low interest rates and trillions of dollars in quantitative easing by central banks created the wave of inflation that continues to sweep the globe, along with massive levels of debt and all kinds of economic bubbles.

If you listen to the mainstream narrative, you would think inflation just came out of nowhere, and central banks are innocent victims nobly struggling to save the day by raising interest rates. Pundits fret about rising rates but never mention that rates were only so low for so long because of the actions of central banks. And they seem oblivious to the consequences of those policies.

But being oblivious doesn’t shield you from the impact of those consequences.

In reality, central banks and governments implemented policies intended to incentivize the accumulation of debt. They created trillions of dollars out of thin air and showered the world with stimulus, unleashing the inflation monster. And now they’re trying to battle the dragon they set loose by raising interest rates. This will inevitably pop the bubble they intentionally blew up. That’s why the World Bank is forecasting Great Recession-era growth. All of this was entirely predictable.

After all, artificially low interest rates are the mother’s milk of a global economy built on easy money and debt. When you take away the milk, the baby gets hungry. That’s what’s happening today. With interest rates rising, the bubbles are starting to pop.

And it’s probably going to be much worse than most people realize. There are more malinvestments, more debt, and more bubbles in the global economy today than there were in 2008. There is every reason to believe the bust will be much worse today than it was then.

In other words, you can strike “short” and “shallow” from your recession vocabulary.

Even the World Bank is hinting at this.

Tyler Durden Wed, 06/07/2023 - 15:20

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DNAmFitAge: Biological age indicator incorporating physical fitness

“We expect DNAmFitAge will be a useful biomarker for quantifying fitness benefits at an epigenetic level and can be used to evaluate exercise-based interventions.”…

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“We expect DNAmFitAge will be a useful biomarker for quantifying fitness benefits at an epigenetic level and can be used to evaluate exercise-based interventions.”

Credit: 2023 McGreevy et al.

“We expect DNAmFitAge will be a useful biomarker for quantifying fitness benefits at an epigenetic level and can be used to evaluate exercise-based interventions.”

BUFFALO, NY- June 7, 2023 – A new research paper was published in Aging (listed by MEDLINE/PubMed as “Aging (Albany NY)” and “Aging-US” by Web of Science) Volume 15, Issue 10, entitled, “DNAmFitAge: biological age indicator incorporating physical fitness.”

Physical fitness is a well-known correlate of health and the aging process and DNA methylation (DNAm) data can capture aging via epigenetic clocks. However, current epigenetic clocks did not yet use measures of mobility, strength, lung, or endurance fitness in their construction. 

In this new study, researchers Kristen M. McGreevy, Zsolt Radak, Ferenc Torma, Matyas Jokai, Ake T. Lu, Daniel W. Belsky, Alexandra Binder, Riccardo E. Marioni, Luigi Ferrucci, Ewelina Pośpiech, Wojciech Branicki, Andrzej Ossowski, Aneta Sitek, Magdalena Spólnicka, Laura M. Raffield, Alex P. Reiner, Simon Cox, Michael Kobor, David L. Corcoran, and Steve Horvath from the University of California Los Angeles, University of Physical Education, Altos Labs, Columbia University Mailman School of Public Health, University of Hawaii, University of Edinburgh, National Institute on Aging, Jagiellonian University, Pomeranian Medical University in Szczecin, University of Łódź, Central Forensic Laboratory of the Police in Warsaw, Poland, University of North Carolina at Chapel Hill, University of Washington, and University of British Columbia develop blood-based DNAm biomarkers for fitness parameters including gait speed (walking speed), maximum handgrip strength, forced expiratory volume in one second (FEV1), and maximal oxygen uptake (VO2max) which have modest correlation with fitness parameters in five large-scale validation datasets (average r between 0.16–0.48). 

“These parameters were chosen because handgrip strength and VO2max provide insight into the two main categories of fitness: strength and endurance [23], and gait speed and FEV1 provide insight into fitness-related organ function: mobility and lung function [8, 24].”

The researchers then used these DNAm fitness parameter biomarkers with DNAmGrimAge, a DNAm mortality risk estimate, to construct DNAmFitAge, a new biological age indicator that incorporates physical fitness. DNAmFitAge was associated with low-intermediate physical activity levels across validation datasets (p = 6.4E-13), and younger/fitter DNAmFitAge corresponds to stronger DNAm fitness parameters in both males and females. 

DNAmFitAge was lower (p = 0.046) and DNAmVO2max is higher (p = 0.023) in male body builders compared to controls. Physically fit people had a younger DNAmFitAge and experienced better age-related outcomes: lower mortality risk (p = 7.2E-51), coronary heart disease risk (p = 2.6E-8), and increased disease-free status (p = 1.1E-7). These new DNAm biomarkers provide researchers a new method to incorporate physical fitness into epigenetic clocks.

“Our newly constructed DNAm biomarkers and DNAmFitAge provide researchers and physicians a new method to incorporate physical fitness into epigenetic clocks and emphasizes the effect lifestyle has on the aging methylome.”
 

Read the full study: DOI: https://doi.org/10.18632/aging.204538 

Corresponding Authors: Kristen M. McGreevy, Zsolt Radak, Steve Horvath

Corresponding Emails: kristenmae@ucla.edu, radak.zsolt@tf.hu, shorvath@mednet.ucla.edu 

Keywords: epigenetics, aging, physical fitness, biological age, DNA methylation

Sign up for free Altmetric alerts about this article: https://aging.altmetric.com/details/email_updates?id=10.18632%2Faging.204538

 

About Aging-US:

Launched in 2009, Aging publishes papers of general interest and biological significance in all fields of aging research and age-related diseases, including cancer—and now, with a special focus on COVID-19 vulnerability as an age-dependent syndrome. Topics in Aging go beyond traditional gerontology, including, but not limited to, cellular and molecular biology, human age-related diseases, pathology in model organisms, signal transduction pathways (e.g., p53, sirtuins, and PI-3K/AKT/mTOR, among others), and approaches to modulating these signaling pathways.

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