IS YOUR BANK ON THIS LIST ??panic spread following the collapse of Silicon Valley Bank.

With amazing speed and impeccable timing, Erica Jiang, Gregor Matvos, Tomasz Piskorski, and Amit Seru analyze how exposed the rest of the banking system is to an interest rate rise.

Recap: SVB failed, basically, because it funded a portfolio of long-term bonds and loans with run-prone uninsured deposits. Interest rates rose, the market value of the assets fell below the value of the deposits. When people wanted their money back, the bank would have to sell at low prices, and there would not be enough for everyone. Depositors ran to be the first to get their money out. In my previous post, I expressed astonishment that the immense bank regulatory apparatus did not notice this huge and elementary risk. It takes putting 2+2 together: lots of uninsured deposits, big interest rate risk exposure. But 2+2=4 is not advanced math.

How widespread is this issue? And how widespread is the regulatory failure? One would think, as you put on the parachute before jumping out of a plane, that the Fed would have checked that raising interest rates to combat inflation would not tank lots of banks.

Banks are allowed to report the "hold to maturity" "book value" or face value of long term assets. If a bank bought a bond for $100 (book value) or if a bond promises $100 in 10 years (hold to maturity value), basically, the bank may say it's worth $100, even though the bank might only be able to sell the bond for $75 if they need to stop a run. So one way to put the issue is, how much lower are mark to market values than book values?

The paper (abstract):

The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity. Marked-to-market bank assets have declined by an average of 10% across all the banks, with the bottom 5th percentile experiencing a decline of 20%.

... 10 percent of banks have larger unrecognized losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks have lower capitalization than SVB. On the other hand, SVB had a disproportional share of uninsured funding: only 1 percent of banks had higher uninsured leverage.

... Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. ... these calculations suggests that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs.

Data:

we use bank call report data capturing asset and liability composition of all US banks (over 4800 institutions) combined with market-level prices of long-duration assets.

How big and widespread are unrecognized losses?

The average banks’ unrealized losses are around 10% after marking to market. The 5% of banks with worst unrealized losses experience asset declines of about 20%. We note that these losses amount to a stunning 96% of the pre-tightening aggregate bank capitalization.

Percentage of asset value decline when assets are mark-to- market according to market price growth from 2022Q1 to 2023Q1

Most banks operate with (to my mind) tiny slivers of capital -- 10% or less. So 10% decline in asset value is a lot! (Banks get money by issuing stock and borrowing. The capitalization ratio is how much money banks get by issuing stock/assets. Capital is not reserves, liquid assets "held" to satisfy depositors.) In the right panel, the problem is not confined to small banks and small amounts of dollars.
But...all of this is slightly old data. How much worse will this get if the Fed raises interest rates a few more percentage points? A lot.

Comment by carol ann parisi on March 16, 2023 at 8:58pm: What Really Happened to Silicon Valley Bank – and What It Means for You

Shah Gilani Mar 16, 2023

Newsflash: Even if Silicon Valley Bank (SVB) was stress-tested by the Fed, their problems would not have been unearthed, though they were more than understood by Goldman Sachs. SVB’s problems were, in fact, used by Goldman to “help” SVB, which immediately buried the bank and grossly enriched the great vampire squid. (It’s my analogy for Goldman – I’ll explain in a minute.)

The run-up to the end-story on SVB is they took in a ton of deposits during the pandemic, which they mostly used to buy Treasury bonds and mortgage-backed securities, which all fell in value as the Fed raised rates, while at the same time depositors were drawing down their balances.

From March 2020 to March 2021, Silicon Valley Bank’s deposits doubled, going from $62 billion to $124 billion, thanks to inactivity due to the Pandemic. Venture capital firms parked newly raised funds in SVB, as did their portfolio companies from startups to unicorns, and not just in the United States. SVB’s reach was global. By the way, SVB wasn’t the only bank taking in tons of deposits.

Your first note to self here, people, is that deposits are “liabilities,” not assets. They can exit as quickly as they entered an institution. Those deposits are used to finance “assets.”

In the case of SVB most of the assets the bank purchased were safe assets, boring stuff like U.S. Treasuries and agency mortgage-backed securities, and of course they had a loan portfolio.

But, because there was no yield on bonds on account of the Federal Reserve manipulating interest rates lower, as in down to zero on overnight fed funds, SVB bought longer-dated bonds, like 10-year Treasuries. That’s because the only “decent” yields, if you call 1% to 2% decent, the bank could get were on longer dated maturity bonds.

So, that’s what they bought. (By the way, SVB wasn’t the only bank buying longer maturity paper for their piddling but decent yields.)

Then the Pandemic subsided, and things got back to some semblance of normalcy, except for what the Fed called a bout of “transitory” inflation. And to combat that inflation, the Fed, starting in March of last year, began raising interest rates. Of course, once again the Fed got it wrong, and inflation wasn’t transitory but more embedded in the economy. So they kept raising rates, lifting the fed funds rate in a year from zero to a range of 4.50% to 4.75% today.

Your second note to self here, people, is that when rates rise, prices of bonds that pay a lower rate of interest always fall. That’s because no one buying a bond today is going to buy a bond yielding 2% when they can get one that has the same maturity and now yields 4%. So, anyone trying to sell 2% yielding bonds has to sell them for a lot less than what the price of a 4% bond costs. Mathematically, the price of the lower yielding bond will fall to where the total yield or return is equal to 4%, by virtue of the price being discounted.

As interest rates rose, the assets on SVB’s balance sheet, its 1% and 2% yielding bonds, fell in price, even though they didn’t plan on selling them. By the way, SVB isn’t the only bank sitting on assets that have been marked down dramatically.

While theoretically SVB parked those assets in a bucket labelled “held-to-maturity” (meaning they planned on keeping them), as depositors withdrew money, partly because startups were burning through cash and VC firms weren’t raising more money and pulling money for various reasons, deposits became real liabilities. As more deposits left SVB, deposits which financed all those low yielding assets on the bank’s balance sheet being marked down, SVB decided to sell a chunk of its portfolio of bonds.

Enter Goldman Sachs, the vampire squid.

What was happening to SVB’s balance sheet surfaced at fiscal year-end 2022 when the bank revealed an almost $15 billion mark-to-market loss on its held-to-maturity portfolio, meanwhile its equity wasn’t much more than $16 billion. The trouble the bank was in looked like it came out of nowhere, only it was developing all year.

The Federal Reserve Bank of San Francisco oversees SVB, but they didn’t flag the bank for its problems. Even if SVB was subject to the Fed’s stress tests for systemically important banks, which given SVB’s size it wasn’t considered systemically important, the bank would have passed.

That’s because, as inane and frightening as this sounds, the Fed’s 2022 stress tests’ adverse scenario on interest rate risk had banks calculate losses if “Ten-year Treasury yields increase from around 1.5 percent to around 2.5 percent at the end of the scenario.” I’m not joking. Towards the end of October 2022, the 10-year Treasury was yielding 4.24%, 70% more than the Fed’s worst case scenario.

How’s that for Fed expectations? And they were the ones raising rates. So much for the Fed getting anything right, anything.

But stress tests and Fed incompetency are stories for another day.

Meanwhile, Goldman Sachs, as SVB’s adviser helping the bank manage its problems, which were suddenly about more deposits being withdrawn and a badly dented portfolio of assets, offered a solution. Goldman would take some of the bank’s impaired portfolio off its hands and then help SVB raise $2.25 billion in fresh equity capital in the form of a sale of new shares.

So, on Tuesday of last week, March 7, Goldman bought a portfolio of SVB’s bond assets, with an average yield of 1.79%, with a supposed book value of $23.97 billion, for a “negotiated price” of $21.45 billion. The next day, March 8, SVB announced a planned share raise of $2.25 billion to fill a hole of $1.85 billion in its balance sheet, a hole just caused by Goldman, and everyone freaked out.

Suddenly being told SVB needed fresh equity capital on account of a recent $1.85 billion hole in its balance sheet was frightening to equity investors, who started selling their shares, and to depositors who started furiously withdrawing money from the bank to the tune of $42 billion the following day, March 9th.

And that was GAME OVER for SVB.

But not for Goldman Sachs, who I’d bet my bottom dollar shorted SVB stock as soon as they bought their bond portfolio, and in a matter of a few days reaped a windfall on the new portfolio it just bought as bond prices spiked in a “flight to quality,” on account of some black swan banking crisis supposedly no-one saw coming.

Your third note to self, people, is that someone always knows something, especially the party causing the something.

I hope you noticed the “by the way” comments in here, if you didn’t reread this, because by the way what happened to SVB is happening to all banks in the U.S. and most global banks.

Note to self #4, people – the whole world’s dealing with the repercussions of central banks artificially manipulating interest rates too low for too long, the resulting stockpiling of low yielding assets on banks’ balance sheets bought with leverage because short-term financing money was practically free, and the marking down of those balance sheet assets as those same central banks raised rates, which is causing depositors to withdraw money from banks that don’t pay interest on deposits to park in 3%-4% yielding money market funds and juicy yielding risk-free Treasury bills, notes and bonds.

That’s what markets are freaking out about.

If bank equity prices keep falling it means their tier-1 capital is shrinking and they’ll have to add more equity capital or reduce their balance sheets to meet reserve requirements. Trying to raise equity by selling more shares when your share price is falling is a fool’s errand. Selling balance sheet assets that are already underwater to just about anyone who already owns bonds that are themselves underwater is a recipe for engendering an ugly negative feedback loop.

The stock market is especially vulnerable here on account of rising rates, stubborn inflation, and now a potentially global banking crisis.

Either buy put options on benchmark index ETFs like the SPDR S&P 500 ETF Trust (SPY) and Invesco QQQ Trust Series 1 (QQQ), or stay on the sidelines until bank stocks stop declining, or the Fed and Treasury pull out more bazookas and fire liquidity lifelines to banks and bondholders.

I like buying the too-big-to-fail giant banks on dips here on account of them being, well, too big to fail.

And if the market breaks hard to the downside, I’d be looking for great companies selling for bargain basement prices, as this might be the shakedown and shakeout smart investors have been waiting for, for a decade now.

Comment by carol ann parisi on March 16, 2023 at 8:58pm

Comment by carol ann parisi on March 16, 2023 at 7:47pm

Comment by carol ann parisi on March 16, 2023 at 4:26pm

Comment by carol ann parisi on March 15, 2023 at 6:20pm: Cita

del's Griffin Slams SVB Bailout: American Capitalism Is "Breaking Down Before Our Eyes"

BY TYLER DURDEN

TUESDAY, MAR 14, 2023 - 08:24 AM

In contrast to billionaire Bill Ackman's praise for the federal government's bailout of SVB depositors, Citadel founder Bill Griffin is not impressed, telling The FT that this action by US regulators shows American capitalism is “breaking down before our eyes”.

As a reminder, the FDIC’s Deposit Insurance Fund normally guarantees up to $250,000 in deposits, which protects small retail customers including mom-and-pop businesses. Banks pay for this guarantee with insurance premiums, but the insurance fund isn’t intended to backstop deposits of bigger customers with more capacity to weather losses if a bank goes under.

Yet, as The Wall Street Journal's Editorial Board remarks, after venture capitalists (Democratic donors) and Silicon Valley politicians howled, the FDIC on Sunday announced it would cover uninsured deposits at SVB and Signature Bank under its “systemic risk” exception.

Apparently, Silicon Valley investors and startups are too big to lose money when they take risks. They benefited enormously from the Fed’s pandemic liquidity hose, which caused SVB’s deposits to double between 2020 and 2021. SVB paid interest of up to 5.28% on large deposits, which it used to fund loans to startups.

But now the FDIC is guaranteeing a risk-free return for startups and their investors.

Uninsured deposits normally take a 10% to 15% hair cut during a bank failure. Some 85% to 90% of SVB's $173 billion in deposits are uninsured. The cost of this guarantee could be $15 billion.

The White House says special assessments will be levied on banks to recoup these losses.

That means bank customers with less than $250,000 in deposits will indirectly pay for this through higher bank fees. In other words, this is an income transfer from average Americans to deep-pocketed investors.

Griffin warned a year ago that price pressures will remain stubbornly persistent, forcing policymakers to need to hit the brakes "hard", which will likely cause a recession, which, he warned, will leave the West facing "existential" problems.

A year later, he was proved right as The Fed's aggressive rate-hikes "broke something"...

“The US is supposed to be a capitalist economy, and that’s breaking down before our eyes,” he said in an interview on Monday.

“There’s been a loss of financial discipline with the government bailing out depositors in full,” Griffin added.

This action by regulators raised the risk of increasing moral hazard, as WSJ notes, many banks have hedged their interest-rate risk and diversified their deposits, which comes at a business cost, but some like SVB and Signature didn’t.

Now, the Fed is now saying that’s OK - we’ve got your back.

This didn't need to be the way as Griffin notes the strength of the US economy meant such a forceful action was not necessary.

“It would have been a great lesson in moral hazard,” he said.

“Losses to depositors would have been immaterial, and it would have driven home the point that risk management is essential.”

“We’re at full employment, credit losses have been minimal, and bank balance sheets are at their strongest ever. We can address the issue of moral hazard from a position of strength.”

Finally, while The White House's first instinct, even in a financial panic, was to spin reality and hunt for political scapegoats, Griffin points the finger directly at the bureaucracy:

“The regulator was the definition of being asleep at the wheel."

But we are sure, no government employee will ever be held accountable for 'missing' this risk - likely busying themselves with diversity and inclusion 'threats'.

We give the last word to Satyajit Das, who summed the sad state of affairs up perfectly: The moral hazards around bailouts are well known.

It seems now that tech start-ups like banks, auto businesses and anybody with an effective lobbyists are too big to fail even if they are too difficult to understand or to properly manage.

As Herbert Spencer put it:

“The ultimate result of shielding men from the effects of folly, is to fill the world with fools.”

Over the last decade and a half, the economic system and financial practices have become geared around low rates, abundant liquidity and the authorities underwriting risk taking. Moving away from this state of affairs was never going to easy, that is, if it is possible at all.

Comment by carol ann parisi on March 15, 2023 at 5:52pm: The Grumpy Economist: How many banks are in danger? (johnhcochrane....

The Grumpy Economist: How many banks are in danger? (johnhcochrane....

The Grumpy Economist: How many banks are in danger? (johnhcochrane....

Comment by carol ann parisi on March 15, 2023 at 5:50pm

Most banks operate with (to my mind) tiny slivers of capital -- 10% or less. So 10% decline in asset value is a lot! (Banks get money by issuing stock and borrowing. The capitalization ratio is how much money banks get by issuing stock/assets. Capital is not reserves, liquid assets "held" to satisfy depositors.) In the right panel, the problem is not confined to small banks and small amounts of dollars.

But...all of this is slightly old data. How much worse will this get if the Fed raises interest rates a few more percentage points? A lot.

To runs, it takes 2+2 to get 4. How widespread is reliance on uninsured, run-prone deposits? (Or, deposits that were run-prone until the Fed and Treasury ex-post guaranteed all deposits!) Here SVB was an outlier.

The median bank funds 9% of their assets with equity, 65% with insured deposits, and 26% with uninsured debt comprising uninsured deposits and other debt funding....SVB did stand out from other banks in its distribution of uninsured leverage, the ratio of uninsured debt to assets...SVB was in the 1st percentile of distribution in insured leverage. Over 78 percent of its assets was funded by uninsured deposits.

But it is not totally alone

the 95th percentile [most dangerous] bank uses 52 percent of uninsured debt. For this bank, even if only half of uninsured depositors panic, this leads to a withdrawal of one quarter of total marked to market value of the bank.

Uninsured deposit to asset ratios calculated based on 2022Q1 balance sheets and mark-to-market values

Overall, though,

...we consider whether the assets in the U.S. banking system are large enough to cover all uninsured deposits. Intuitively, this situation would arise if all uninsured deposits were to run, and the FDIC did not close the bank prior to the run ending. ...virtually all banks (barring two) have enough assets to cover their uninsured deposit obligations. ... there is little reason for uninsured depositors to run.

... SVB, is [was] one of the worst banks in this regard. Its marked-to-market assets are [were] barely enough to cover its uninsured deposits.

Breathe a temporary sigh of relief.

I am struck in the tables by the absence of wholesale funding. Banks used to get a lot of their money from repurchase agreements, commercial paper, and other uninsured and run-prone sources of funding. If that's over, so much the better. But I may be misunderstanding the tables.

Summary: Banks were borrowing short and lending long, and not hedging their interest rate risk. As interest rates rise, bank asset values will fall. That has all sorts of ramifications. But for the moment, there is not a danger of a massive run. And the blanket guarantee on all deposits rules that out anyway.

Their bottom line:

There are several medium-run regulatory responses one can consider to an uninsured deposit crisis. One is to expand even more complex banking regulation on how banks account for mark to market losses. However, such rules and regulation, implemented by myriad of regulators with overlapping jurisdictions might not address the core issue at hand consistently

Comment by carol ann parisi on March 15, 2023 at 5:48pm

How many banks are in danger?

Comment by carol ann parisi on March 15, 2023 at 5:38pm: Ironically, one of the worst offenders is the Fed itself which has 2.61 T$ of mortgage backed securities on its balance sheet as of last week. https://www.federalreserve.gov/releases/h41/
Mortgage backed are worse than long bonds because increasing rates stretches out their duration.

Release H.4.1 does not disclose what percentage of the Fed's 4.57 T$ of notes and bills are long term.

The Fed, as a bank, is by its own standards woefully undercapitalized. It is carrying total assets of 8.342 T$ on a mere 42.5 G$ of capital. 0.5%.

If the Fed were a bank regulated by the Fed, it would put itself in receivership.

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IS YOUR BANK ON THIS LIST ??panic spread following the collapse of Silicon Valley Bank.

What Really Happened to Silicon Valley Bank – and What It Means for You

del's Griffin Slams SVB Bailout: American Capitalism Is "Breaking Down Before Our Eyes"

How many banks are in danger?

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