We have reached the time again when those in charge of the big banks as well as the bank supervisors appointed by politicians are not telling us the full truth again. They try to calm us down or decline or simply outright lie to us. The same narrative all over again. They want to inject us with a sedative to counter the rising nervousness. Here are just a few examples:
JPMorgan boss Jamie Dimon: “The US banking system is extraordinarily robust.”
Brian Moynihan, CEO of Bank of America: “There have been disruptive tendencies in the market for a few weeks, but there can be no talk of a crisis.”
Mark Branson, head of the German BaFin: “So far we have not seen any danger of a systemic crisis here.”
In order to be able to realistically assess the processes that are now taking place, you have to remember 2 important terms and a number in particular.
Let’s deal with the number first. US deposit insurance only protects assets up to $250,000 (in Europe it is even lower at €100,000). The consequence is, if your bank fails, anything above this threshold of your assets simply disappear.
The first term that matters in this context is: “bank run”.
Big customers do not wait until their bank collapses to run into their banks flee with their deposits. They run before. The bank does not even have to be on fire. Even the rumour is enough to get a bank run started. Nobody wants to be the last in a house on fire.
After the bank run, the second key term comes into play: “interest rate stress”.
The bank has to sell parts of its own assets in order not to get into balance sheet trouble. Due to the interest rate change of the central banks, serious write-downs have to be made here. For many institutes, interest rate stress is just a code name for meltdown.
Here are the 5 problems that revolve around those 2 terms and 1 number and should us pay attention.
Problem 1: The interest rate stress is dampened by anesthesia
The failures of Silicon Valley Bank (SVB), Signature and First Republic were not the result of bad management but the result of systemic risk at regional banks in the US. Like other banks, these hold government and mortgage bonds whose prices have fallen due to the rise in interest rates. The papers are therefore worth less for the banks. According to Bloomberg, the bookkeeping losses of all US banks on these papers are 600 billion US dollars.
If there is a flight of deposits, as happened at the Silicon Valley Bank, the balance sheet gets into trouble. After the SVB was rescued by a major bank, US regulators decided that government bonds could continue to be used as collateral for new loans despite their expiry at face value. A deceptive calm returned, ultimately based on a balance sheet trick that the state approved in its distress. The interest rate stress is dampened by anesthesia, but not eliminated.
Problem 2: More banks in critical condition
The financial problems of the regional banks are greater than initially assumed. In late April, the Federal Deposit Insurance Corporation (FDIC), the United States’ deposit insurance fund, released a presentation highlighting worrying developments in the banking market that should get the alarm bells ringing: In the 3rd quarter of last year, 722 banks reported unrealized losses of more than 50 percent of their equity! But if equity had shrunk so dangerously half a year ago, how far has the financial core melted since then?
It also confirmed: There are 31 banks in a very bad financial situation. With other words: They have more debts than assets and therefore cannot borrow new money from the Federal Home Loan Banks (FHLB). The FHLB are 11 US regional cooperative mortgage lenders that refinance real estate loans for more than 8,000 financial institutions. Without their follow-up financing, the financial leeway of the 31 problem banks will increase.
Problem 3: Commercial real estate is becoming a cluster risk
Regional banks are the primary commercial real estate lenders in the United States. They hold nearly 70 percent of those loans on their books, according to an analysis by Bank of America. A study by JPMorgan Private Bank sees a major risk in commercial real estate, especially in the office sector: “Compared to large banks, small banks have 4.4 times more exposure to US loans than their larger peers.” The study continues, “Within this cohort of small banks, CRE loans account for 28.7 percent of assets, compared to just 6.5 percent at large banks.” That means: The risks have started to accumulate.
Problem 4: Caution, bubble formation!
The situation with commercial real estate is critical not only because of the rise in interest rates, but also because of the new home office regulations of numerous corporations. Vacancies across the country are at their highest since the 1980s, according to data from the rating agency Moody’s. Recently, two large loan defaults caused unrest on Wall Street. A Brookfield fund defaulted on a $785 million loan secured by two Los Angeles office towers. A subsidiary of bond investor PIMCO also failed to repay $1.7 billion in loans. They were secured by offices, including Twitter’s buildings in San Francisco and New York. Under the leadership of Elon Musk, Twitter temporarily stopped paying rent. According to data from the real estate analyst Green Street, office buildings in the USA have already lost 25 percent in value in recent months. If interest rates continue to rise, this development is likely to intensify. A bubble has been created, but when will it burst?
Problem 5: The loss of trust
The regional banks are being watched more closely by their customers and their investors. An indicator of the increase or decrease in confidence is the regional bank index S&P Regional Banking ETF. This index traces the development of 143 US banks that primarily engage in regional lending business. In March, the index collapsed by 23 percent in just five days. Despite the rescue of the Silicon Valley Bank, confidence remained dwindling. To date, the index has slipped another 19 percent.
Conclusion: While big bank bosses and banking supervisors hand out tranquilizers to the public to calm us all down, the heads of the financial industry finally should take action to solve an unsustainable business model, which has been leveraged multiple times and is still underpinned by insufficient equity.
Sven Franssen