JPMorgan Highlights Rising Funding Costs Amid Credit Concerns
JPMorgan Chase & Co. has indicated that growing worries over credit, particularly following the bankruptcies of First Brands and Tricolor, are raising funding costs for banks. Investors are also increasingly anxious about potential hidden risks connected to private equity and hedge fund exposures.
On Monday, JPMorgan analysts weighed in on the effects of last week’s sharp decline in bank stocks, which was triggered by revelations involving two regional U.S. lenders tied to allegations of fraud from their borrowers.
The recent high-profile collapses of First Brands Group, an auto parts manufacturer, and Tricolor Holdings, a subprime auto financing company, have underscored the complexity and lack of transparency in financial relationships between banks and various non-deposit financial institutions (NDFIs).
The bank pointed out that the opacity surrounding lending practices to NDFIs—which encompass private equity firms, private credit agencies, and hedge funds—has led investors to demand greater returns for holding shares in these banks.
“We think the recent turmoil in global banking was largely due to inadequate risk management, as seen in First Brands’ supply chain issues. More critically, it was a result of poor financial disclosures,” JPMorgan analysts stated in a report.
Regulators are increasingly worried about the intricate ties between banks and NDFIs. Earlier this month, the IMF emphasized the necessity for heightened oversight in this area. It’s estimated that U.S. and European banks have a staggering $4.5 trillion linked to a wide array of nonbank financial institutions, averaging about 9% of their total outstanding loans.
The troubles faced by First Brands and Tricolor illustrate that banks can be at risk from corporate defaults even when those failures fall outside traditional lending practices.
Tricolor had secured funding from investors via the asset-backed securities market but also depended on credit lines from major banks like JPMorgan, Fifth Third Bank, and Barclays to bundle subprime auto loans into bonds. All three banks have had to write down their assets as a result.
First Brands, on the other hand, mainly turned to private debt markets for financing, while the asset management divisions of firms such as Jefferies and UBS amassed considerable exposure to invoice-linked loans.
JPMorgan’s analysts noted that U.S. banks’ disclosures often lack detail and fail to convey a complete picture. They pointed out that European banks are even less transparent, with loans classified under broader financing categories, without specific breakdowns provided.
European banks can also record loans connected to NDFIs of entities outside the U.S., as exemplified by the case of Credit Suisse. There are notable risks associated with the failure of the UK operations of Archegos Capital Management, a notable family office.
This situation complicates the ability to trust disclosures from European banks, creating a wider valuation disparity compared to U.S. counterparts, according to JPMorgan.
The analysts expect European banks to disclose more details about their exposures during their third-quarter results announcements beginning this week, in an effort to address these valuation discounts.
Despite the increasing implied cost of equity, JPMorgan projects it will eventually decrease from the current rate of approximately 11.5% to around 10%, supported by solid business fundamentals.
