Bank liquidity became top of mind after Boeing and Hilton tapped their credit lines earlier in March. As concerns about COVID-19 increased, other companies followed suit and tapped their credit lines. In total, JPMorgan estimates that $180 billion of credit lines were drawn in the second and third weeks of March.
More questions arose about bank liquidity when some financial companies, most notably the “Bix Six” U.S. banks (Bank of America, Citigroup, JPMorgan, Wells Fargo, Goldman Sachs and Morgan Stanley), started to issue at scale. In total, they issued $27 billion the week of March 23 and $41 billion across currencies for the month, exceeding the March four-year average of $11 billion (see Figure 1).
Also striking was the pace and number of times these large banks came to market. What started off as a trickle became a blitz. Citigroup, for example, issued $1.3 billion on March 19 only to come back to the market five days later with a $4 billion deal. Goldman Sachs was even more extreme, issuing three deals for $8 billion over two weeks.
Figure 1: Total issuance from the Big Six U.S. banks increased dramatically in March compared to prior years.
Big Six Issuance by Month ($ Billions)
So, do the banks have a liquidity problem? We are comfortable answering “no” to this question.
Cash remains king. As several management teams explained to us, prior to the COVID-19 outbreak, healthy deposit growth coupled with weak loan demand allowed banks to be patient with issuance to enhance profitability. The decision to access the market aggressively was an act of prudence by bank management teams given the unprecedented market volatility, macroeconomic uncertainty, potential for loan growth to support customers, and upcoming quarter-end blackouts, which prohibit them for issuing over a two- to three-week period. We believe these were the primary reasons why the banks went to market, rather than reflecting a need to maintain liquidity and capital buffers. We also take comfort in our observation that the credit market, at least for now, is not telling us that there is an outsized risk, such as liquidity, in the financial system. As seen in Figure 2 below, the spread differential between the Bloomberg Barclays U.S. Aggregate Corporate and Finance indices has widened but nowhere close to what was witnessed in the 2008-2009 financial crisis.
Figure 2: The spread differential between the Bloomberg Barclays U.S. Aggregate Corporate and Finance indices has widened, but not nearly as much as during 2008-2009, suggesting that banks are not the problem in this period of volatility.
Financial vs. Non-Financial Spread Differential (Basis Points)
Source: Bloomberg, Neuberger Berman calculations. Difference in average option-adjusted spread between Bloomberg Barclays U.S. Aggregate Corporate and Finance indices.
Beyond what the management teams and the market are saying, it is important to realize that banks are entering this time of uncertainty from a position of strength, with far stronger liquidity profiles than they had in the lead-up to the 2008-2009 financial crisis. For example, cash and Treasuries at Bank of America, Citigroup, JPMorgan and Wells Fargo on an aggregate basis have increased by 359% from 2007 to 2019. These liquid assets have risen from 4% of total assets in 2007 to 13% of total assets at the end of 2019. Additionally, the Federal Reserve is injecting a significant amount of liquidity into the banking system and markets, lessening the strains on the banks. The Fed’s plan to purchase at least $700 billion of securities should increase deposits at banks by roughly that amount. The central bank has also launched a commercial paper funding facility and a primary dealer credit facility, and encouraged banks to borrow from the discount window.
The Fed is encouraging banks to use liquidity buffers to keep lending, and is also discussing with banks the potential for some degree of leniency if lenders breach key liquidity thresholds. Just recently, the Fed relaxed the leverage ratio, a regulatory ratio designed to limit bank risk-taking, for one year. In a statement, the Fed was clear that the move was meant for banks “to expand their balance sheets as appropriate to continue to serve as financial intermediaries….” If this trend continues, banks will lend, but will need to walk the fine line of supporting customers and protecting the safety and soundness of the financial system. That said, we believe the banks will remain methodical in terms of how they allocate liquidity and capital in this volatile market and will await further clarity from the Fed before expanding their balance sheets.
We remain confident in the soundness of the financial system and continue to view U.S. banks generally as an attractive investment given our constructive view on their heightened liquidity and capital positions since the financial crisis.