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What JP Morgan's Earnings Mean For QE

Jan. 21, 2014 8:07 PM ETJPM, BAC, BCS, C, MFG, SMFG, UBS, DB, HSBC, CS
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What JP Morgan's Earnings Mean for QE By Market Authority

Last week, JP Morgan released earnings of $1.40 a share, beating expectations by 5c. While much of the focus has been on the $20bln of legal settlements in the past year, they announced a lesser-followed number which has implications for the overall economy.

Drum roll, please…

Loan to Deposits (LTD) is at 57% which is the lowest in a decade. That's down from 61% a year ago and much lower than the 88% reported in 2004. This decreasing LTD number is consistent across the rest of the banking sector.

What's the significance of this number? In the past, banks have lent out the majority of money they receive in deposits. This facilitates credit growth and makes the economy grow.

Take a look at the following chart.

Loans to Deposits

The blue line represents the total growth in deposits, something that's continued to grow thanks to Bernanke's printing press. The red line represents bank credit, which dropped sharply in 2008 and has slowly been rebounding (but not as fast as deposit growth).

The divergence between these two numbers (deposits - loans) now stands at a record $2.4trln. Keep this number in mind as I'll reference it later.

So you're probably now asking, "why aren't banks lending?"

1. Credit growth remains weak due to continued economic uncertainty, corporate cash hoarding, and poor wage growth.

2. Continued regulatory uncertainty (what's the latest iteration of Dodd/Frank??) and somewhat unknown capital requirements is forcing banks to keep more cash on their balance sheets.

3. Low rates make some forms of loans unprofitable. Remember, banks borrow short and lend long. There's not much yield in AAA corporates for the risk assumed (approx 4%).

4. Banks are keeping abnormally large reserves with the Fed and earning 25bp. Basically, the banks can borrow cash from the Fed at zero and get paid 25bp a year just for holding the cash with the Fed. This trade has amounted to billions$ in profits for the banks.

I want to focus on #4. It's widely known that QE has resulted in excess reserves in the banking system. These reserves are held at the Fed and not lent out.

If you've been paying attention, can you guess what the number of reserves the banks are currently holding at the Fed (and being paid 25bp's?)

Answer: $2.4trln.

So let me summarize.

The economy is slow because credit growth is slow. You can see this in the decade low Loan To Deposit # of 57%.

Credit growth is slow because banks (which create credit) are opting to keep excess reserves at the Fed and get paid 25bp.

These excess reserves are a creation of QE programs. Without QE, no excess reserves and we might be witnessing faster credit growth and a faster economy.

So, here's what the chart looks like if we add the excess reserves plus the existing credit growth.

Loans to Deposits

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