The US financial system is precariously positioned following the failures of Silvergate (NYSE: SI), Silicon Valley Bank (NASDAQ: SIVB) and Signature Bank (NASDAQ: SBNY).
Regulators have stepped in with emergency measures to contain the fallout from uninsured deposit funding and unrealized losses across asset portfolios, including the launch of the Bank Term Funding Program (BTFP).
Although the S&P 500 heading higher yesterday was a bit of a surprise, this was likely due to expectations that the Fed may shift to looser monetary policy, against last week’s suggestions that a 50-bps rate hike was on the cards.
1. Deposits are flowing out of local and regional banks
Combined, the closure of SVB and Signature has resulted in nearly $265 bn in depositor money being frozen by regulators.
PacWest (NASDAQ: PACW) too reported an outflow of $700mn late last week.
Led by deep losses in First Republic Bank (NYSE: FRC) on Monday, 13th of March, the KBW Nasdaq Bank Index plunged to an all-time low of 79.58.
Depositors, investors, and the financial system at large do not appear convinced with the Fed’s insistence that it is willing to address any and all liquidity issues to shield portfolios and banks from the possibility of a widespread run on the system.
Anxiety around the potential onset of contagion in regional banks and widespread financial instability remains, even though the index improved on Tuesday, 14th of March, closing at 82.67.
Liz Hoffman, Semafor business and finance editor believes that regulators are planning to ‘firehose’ depositors with money, and remarked,
…(regulators are indicating that) we’re not going to stop this but we are going to fund it.
2. Deposits are flowing into the majors
As a result of the turmoil in the banking sector, families and businesses are shifting at least a portion of their assets to the relative safety of globally systemically important banks (G – SIBs), such as JP Morgan (NYSE: JPM), Bank of America (NYSE: BAC), and Citi (NYSE: C).
Bloomberg reported that Bank of America saw massive inflows of more than $15 bn in new deposits over a very compressed period, while insiders report that other majors are also seeing surging deposit inflows that are well above weekly averages.
This shift is being driven by the too-big-to-fail reputation of these institutions combined with the limited uptake of the Fed’s facility that allows banks to take one-year loans against unrealized losses.
3. Unrealized losses in the banking sector top $600 bn
Several banks, including SVB, had parked the bulk of excess deposits acquired during the pandemic in the relative safety of 10-year treasuries.
However, with the slowdown in the tech sector, failing startups and the sharp rise in bond yields from under 1% in 2020, to 3.67% today, many such institutions accumulated deep losses in their asset portfolios.
As per data from the Federal Deposit Insurance Corporation (FDIC), collective unrealized losses on investment securities for the banking sector stand at an alarming $620 bn.
This implies that in the event of a liquidity crunch, banks will be unable to monetize their holdings to meet their obligations.
Fearing a repeat of bank failures last week, depositors are withdrawing their holdings en masse from institutions that could be at high risk of contagion, further exacerbating financial conditions.
4. Interbank lending troubles
The FRA-OIS spread is an indicator of the health of the interbank lending market.
Essentially, it compares the gap between three-month forward rates of bank borrowing versus the overnight or current rate.
Ideally, the spread should be quite small, which would indicate confidence in the banking entity.
On Wednesday, 8th March, the FRA-OIS spread stood at a subdued 3.10, before rising to 8.20 on Friday, the 10th of March.
On Monday, it sky-rocketed to a mind-boggling 59.80, surging to its highest levels since the fall of Lehman Brothers (excluding the covid era) and rung alarm bells of liquidity drying up as banks feared lending to one another.
This implied that the banks themselves were not satisfied by the intervention of regulators to protect depositor value, and suspect deeper issues within interbank lending.
Fortunately, much like equities, the spread did see some relief on Tuesday, 14th March moderating to 33.90 at close, comparable to October 2022 levels.
Optimistically, this is well below the GFC levels which were approaching 200.
However, Steven van Metre, CFP, who is an insurance broker and Investment Advisory Representative of Atlas Financial Advisors, Inc, warned,
.…we’re seeing a surge in money still flowing out of the regional banks…and what I want to suggest to you is this is going to continue. This isn’t just a one or two-day issue.
5. Downgrades coming?
Moody’s echoed this view and placed several well-known banks under review for potential downgrades, including Comerica Inc., Intrust Financial Corp., and Western Alliance.
In a report, the rating agency noted,
We expect pressures to persist and be exacerbated by ongoing monetary policy tightening…
6. Local and Regional banks set to increase their borrowing
As discussed above, FDIC-insured banks are, or could soon be in dire straits due to the sheer volume of unrealized losses.
This prevents bank leadership from efficiently raising funds when they need it most, threatening customer confidence.
In a strong indication that the state of regional banks is about to deteriorate further, Van Metre notes that the Federal Home Loan Banks (FHLB) system raised a massive $88.7 bn in short-term debt to cover additional funding demand, as more depositors and startup investors look to withdraw their capital.
Regarding the Fed’s upcoming rate decision, Padhraic Garvey, CFA; Benjamin Schroeder and Antoine Bouvet at ING noted,
…No need for a hike right now if the weak system is showing vulnerability.
In international banking news, trading in Credit Suisse stocks was suspended after prices crashed by 24% earlier today, hitting an all-time low for a second consecutive day. A detailed article on the latest developments is available here.
Source: https://invezz.com/news/2023/03/15/6-key-signals-of-rising-financial-stress-in-the-us-banking-system/