Silicon Valley Bank’s blunders were encouraged by US regulation, went untested by the Federal Reserve and were “hiding in plain sight” until Wall Street and depositors grew alarmed.
That’s JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon’s assessment of the US banking crisis that sent markets careening last month, an episode he predicts is “not yet over” and will be felt for years. He said US authorities shouldn’t “overreact” with more rules.
In his wide-ranging annual letter to shareholders on Tuesday, Dimon described his firm’s aspirations for using artificial intelligence and ChatGPT, weighed in on geopolitics, and provided updates on JPMorgan’s activities in Ohio. This time, many of his sharpest remarks ripped at regulation, including capital rules that pushed banks to binge on low-interest assets that lost value as interest rates shot up.
“Ironically, banks were incented to own very safe government securities because they were considered highly liquid by regulators and carried very low capital requirements,” Dimon said. “Even worse,” he added, the Federal Reserve didn’t stress-test banks on what would happen as rates jumped.
When Silicon Valley Bank’s uninsured depositors realized it was losing money selling securities to keep up with withdrawal requests, they raced to pull their cash. Regulators then intervened and seized it.
Yes. Banking regulators were so focused on credit-exposure of banks (remember the subprime crisis of 2008?) that they really screwed up by having banks load-up on low credit-risk assets that usually have interest rate risk associated with them like Treasuries and mortgage-backed securities (MBS). What could go wrong?
What went wrong was that interest rates rose and unrealized losses on Treasuries and Agency MBS exploded.
Here is a chart of urealized losses on investment securities that banks have accumulated.
Apparently, The Fed and FDIC (and the myriad of Federal and State regulators) sit high on a mountain top and ignore interest rate risk.
Not only did the ISM Manfacturimng Report on New Business Order fall to 44.3, but price PAID also fell as The Fed hikes rates (yellow line) and slowing M2 Money growth (green line).
Office REITs are really hurting as Count Powellula sucks the blood (liquidity) from the market.
Count Powellula. “I vant to suck the blood from your economy.”
The Federal Reserve raised their target rate just once under President Obama until Donald Trump was elected. Then raised their target rate 8 times AFTER Trump was elected. In other words, Bernanke/Yellen kept the target rate near 0% for too long. When you throw the insane level of spending by Biden and Congress on top of the massive Fed stimulus. Now The Fed is trying to remove the excessive monetary stimulus by raising rates which is crushing banks.
Small bank reserces are low.
In any case, rate hikes are causing turmoil at small banks (as witnessed by the failures of SVB, Silvergate, First Republic and Signature Banks. Even worse, small banks hold 70% of commercial real estate loans.
Money managers have stepped up their bearish bets against office landlords, wagering that the US regional banking crisis will slash the availability of credit to property owners that were already suffering from the pandemic and rising interest rates.
Hedge funds are using credit derivatives and equities to bet against the companies and their debt. Almost 40% of shares in the iShares US Real Estate ETF are sold short, the highest proportion since June, according to data from analytics firm S3 Partners.
At Hudson Pacific Properties Inc., short interest reached a record 7.4% earlier this week before dropping to about 5% of shares outstanding, according to data compiled by IHS Markit Ltd. That’s almost double the level a month ago. For Vornado Realty LP, short interest is the highest since January.
Three regional banks have failed in the US, raising concerns about the implications for commercial real estate finance. Many lenders are losing deposits, which might cut into their ability to finance real estate in the future. Regional banks account for about 80% of bank lending to commercial properties, according to economists at Goldman Sachs Group Inc.
“What’s changed in the last few weeks is the credit markets,” said Rich Hill, chief of real estate strategy research at Cohen & Steers Capital Management Inc. “It went from a story of work-from-home and the impact on occupancy and the lack of rent growth to also the compounding of tighter financial conditions given everything happening with banks.”
Fears of tighter credit are adding to risks for offices that have been building for some time, Green Street analysts wrote in a Tuesday report. Hedge fund manager Jim Chanos, Marathon Asset Management and Polpo Capital Management founder Daniel McNamara are among those who have been betting for months that landlords will struggle to lure staff back to workplaces.
“This regional banking crisis is just throwing fuel on the fire,” McNamara said in a telephone interview. “I just don’t see a way out of this without a lot of pain in the office sector.”
Vulnerable Landlords
Real estate was already the most shorted industry across global equities, according to a March 17 report by S&P Global Inc. It was the third most-shorted sector in the US.
That’s in part because interest rates have been climbing for the last year, which pressures real estate owners. Defaults remain low for now. But office assets are the collateral for about $100 billion of the $400 billion of US commercial real estate debt maturing this year, according to MSCI Real Assets.
Workplaces worth nearly $40 billion face a higher probability of distress, more than apartments, hotels, malls or any other type of commercial real estate, MSCI said on Wednesday. Almost $20 billion of office loans that were bundled into commercial mortgage-backed securities and are due to mature by the end of next year are already potentially distressed, Moody’s Investors Service estimates.
Credit availability for commercial real estate was already challenged this year as investors have grown less interested in buying commercial mortgage bonds, JPMorgan Chase & Co. analysts including Chong Sin wrote in a note. Sales of CMBS deals without government backing have fallen more than 80% this year, according to data compiled by Bloomberg News.
Smaller banks potentially retreating may bring a credit crunch to smaller markets, the JPMorgan analysts wrote.
Lenders advanced a record $862 billion to commercial real estate last year, a 15% increase from a year prior, data provider Trepp estimates. Much of that was driven by banks, which originated 50% more loans in the period. The pace of growth has slowed since then, Federal Reserve data show, as the outlook for real estate grows increasingly negative.
The pressure on offices means lending standards are now being tightened, bad news for landlords that have high levels of leverage and putting lenders at a higher risk of defaults.
“Recent developments have increased downside risk to commercial real estate values from expectations of tightening lending standards,” Morgan Stanley analysts including Ronald Kamdem wrote in a note on Monday. Office REITs may have to sell assets to help them successfully refinance, they said.
Shorts soared on office landlords last year as rising interest rates weighed on the industry. They dropped subsequently as investors wagered that borrowing benchmarks would top out at a lower level than initially expected or the Federal Reserve would begin to cut the rates earlier than previously expected.
Cohen & Steers, which oversees about $80 billion, including $48 billion in real estate investments, went under weight on offices during the pandemic and will steer clear until the market shows signs of hitting a floor.
“I actually want to see more signs of weakness,” Hill said. “The more headlines I see that things are really, really bad, the closer I think we are to the end.”
Chanos Short
Chanos said on CNBC in January that he had been betting against SL Green Realty Corp., short interest in which reached the highest since the financial crisis in recent days. The landlord’s assets include a New York building occupied by Credit Suisse Group AG, the lender taken over by UBS Group AG after government-brokered talks. Short sellers borrow stock and sell it, planning to profit by buying it back at a lower price later.
An SL Green spokesperson directed Bloomberg to company comments at a March 6 investor conference, before the recent bank failures.
The landlord plans to sell $2 billion of properties, cut its debt by $2.5 billion and refinance a $500 million mortgage, Chairman and CEO Marc Holliday said at the Citigroup Inc. conference. Because the securitization market and life insurance financing weren’t receptive to deals, the firm is dependent on banks, which were already an uphill challenge.
“Banks are more likely to say no these days than to execute,” Holliday said. “Knock on wood, hopefully we can get that done.”
Mark Lammas, president of Hudson Pacific, said in an emailed statement that the firm is confident in its business fundamentals and long-term prospects. The company is investment-grade, a majority of its assets are unencumbered, it has $1 billion of liquidity, and no material debt maturities until 2025, Lammas said.
Chanos and representatives of Vornado and Boston Properties didn’t immediately reply to requests for comment.
‘The Widowmaker’
Hedge funds have also been using credit-default swaps indexes known as CMBX to bet against CMBS that are most exposed to offices. The derivatives are tied to portions of bonds backed by commercial mortgages and a number of them reached a record low this week amid fears about a number of regional banks.
Betting against commercial real estate has historically been a hard way to make money, because it can take a long time for losses to emerge, and the range of possible outcomes for even troubled property can be wide. “Shorting CMBX BBB- is regarded as the widowmaker — the undoing of many a young trader’s career,” Morgan Stanley trader Kamil Sadik wrote in a March 6 note.
But the spate of bad news means the BBB- portion of the 14th CMBX index is at the lowest level ever and the same part of the 13th index is at its lowest since the pandemic in 2020. Similar declines are also being seen in share prices of office landlords.
“Our conversation with investors suggests that there has been some capitulation and forced selling as the stocks have continued to underperformed,” Morgan Stanley analysts led by Kamdem wrote.
So far in 2023, there has been 17 downgrades of CMBS deals with no upgrades.
Investors are fleeing to money market funds as The Fed hits the brakes.
As The Fed attempts to fight inflation, rates are rising. Consequently, deposits are all commercial banks are falling.
The Fed just released its weekly commercial bank data dump showing deposit inflows/outflows.
Two things to note:
1) This is for the week up to 3/15/23 (which includes the SVB collapse but nothing more)
2) ‘Large Banks’ includes the top 25 banks (which means SVB was among that group, hence, we get no indication of SVB rotation flows)
The overall data shows that domestic commercial banks saw over $98 billion in deposit outflows (seasonally-adjusted) that week to just over $17.5 trillion (8th straight week of aggregate outflows).
Source: Bloomberg
That is the largest (seasonally-adjusted) outflow since April 2022 (tax-related?) as we suspect much of that flowed into money-markets. Deposits have been on a steady decline over the past year or so, falling $582.4 billion since February 2022.
There was a notable rotation however with the large banks seeing deposit inflows of $117.9 billion on a non-seasonally-adjusted basis (the biggest weekly inflow since Dec 2021).
Small banks, on the hand, saw a massive $111 billion outflow (non-seasonally-adjusted)…
Source: Bloomberg (note different scales)
That is the largest weekly outflow ever (by multiples) and drops ‘small bank’ total deposits to the lowest since Sept 2021…
Source: Bloomberg
Bear in mind this data does not include the last 10 days, where we have US regional banks all tumbling further and Yellen offering no guaranteed deposits, FRC stock collapse amid bailouts (though that will skew the data due to that $30bn infusion), and the fear of Credit Suisse’s collapse.
Will banks start to compete for deposits? (Well not the biggest ones, for sure)…
I feel like I am watching the Star Trek original series episode “The Doomsday Machine” as former Fed Chair and current US Treasury Secretary effectively just guaranteed ALL US bank deposits. Aka, a massive bank bailout. The episode was about a robot space vehicle that destroy planets … and anything in its path. And if it changed course to destroy something, it gradually returned to its original destructive path. Like The Federal Reseve.
But after a few days of declining Treasury yields because of the mess created by Bernanke/Yellen’s too low for too long policies, and the Biden/Congress insane spending, the US Treasury 2-year yield is up 16.1 basis points.
Whether it was politcally motivated to protect Obama/Biden or Obama/Biden’s economic recovery was terrible, The Fed only raised their target rate once before Trump’s election. And then Yellen raised rates like crazy. Only to hand her mess off to Powell who had to drop rates like a rock and massively expand the balance sheet … again … to fight Covid.
Argetina’s inflation rate just hit 102.5% as their M2 Money printing hit 80%
Argentina’s central bank is considering raising its benchmark rate on Thursday for the first time since September after inflation data showed prices increased by more than 100% annually last month, according to two people with direct knowledge.
The monetary authority’s board will consider an increase after leaving the key Leliq rate unchanged at 75% for several months, the people said, asking not to be named discussing internal decisions. The board has not yet decided on the size of the hike in case they opt for such move, they said.
A cautionary tale for Washington DC spendacrats and Fed officials.
Brought to the same country that gave us Statist Juan Peron and his wife Eva.
The Silicon Valley Bank failure (along with NY’s Signature Bank) are sending shock waves through the global economy. Not because of the incompetence of bank regulators, but because of the reaction function from the FDIC and Fed.
The 10-year Treasury yield is down -26 basis points in the AM. And the Fed Funds Target Rate is expected to drop to 4.7%.
Its not just the US Treasury yield that declined -26 basis points. European sovereign yields are down too (Germany 10-year is down -32.9 basis points).
Look at the 2-year Treasury yield. Its down -54.6 basis points.
On a sad note, Resident Biden is calling for stricter regulations for the banking industry, already one of the most regulated sectors of the economy. How about less politics and just make them do their ^*T^R jobs!
Despite cries from Summers, Yellen and other the DC illuminati (Biden is oddly silent), US banks are NOT fine. In fact, banks in general are suffering from Fed rates increases due to holding of long-term Treasuries and MBS.
In fact, The Federal Reserve’s fight against inflation is causing serious problems, as exemplified by AOC. No, not THAT AOC. but bank Accumulated Other Comprehensive Income.
Accumulated Other Comprehensive Income (AOCI) are special gains and losses that are listed as special items in the shareholder equity section of a company’s balance sheet. The AOCI account is the designated space for unrealized profits or losses on items that are placed in the other comprehensive income category.
On the regulatory call reports, AOCI is added to regulatory capital. Since SVB’s AOCI was negative (because of its unrealized losses on AFS securities) as of Dec. 31, it lowered the company’s total equity capital. So a fair way to gauge the negative AOCI to the bank’s total equity capital would be to divide the negative AOCI by total equity capital less AOCI — effectively adding the unrealized losses back to total equity capital for the calculation.
Getting back to our list of 10 banks that raised similar red margin flags to those of SVB, here’s the same group, in the same order, showing negative AOCI as a percentage of total equity capital as of Dec. 31. We have added SVB to the bottom of the list. The data was provided by FactSet:
Or this chart of vulnerable banks from Morningstar of unrealized losses and liquidity risk.
Here is a snapshot of SVB’s balance sheet. Or UNbalanced sheet.
After Congress passed the greatly flawed Dodd-Frank banking legislation, bailouts of banks are prohibited. But bank BAIL-INs still exist. Banks use money from their unsecured creditors, including depositors and bondholders, to restructure their capital to stay afloat. Put simply, they can convert their debt into equity to increase their capital requirements. Although depositors run the risk of losing some of their deposits, banks can only use deposits in excess of the $250,000 protection provided by the Federal Deposit Insurance Corporation (FDIC).
In any case, the FDIC and Fed are weighing a special vehicle after SVB swiftly collapses. Special vehicle? Sounds an awful like the mega bank bailout of 2008 under Hank Paulson.
One indicator that the Biden Administration will herald is that average hourly earnings rose to 4.6% Year-over-year (YoY). Too bad headline inflation is still at a whopping 6.4% YoY.
More jobs were added to the US economy than forecast (311k actual versus 225k forecast). The U-3 unemployment rate rose to 3.6% from 3.4% in January.
The aftermath of the jobs report? 2-year Treasury yields are down a whopping -15.8 basis points. But Europe is seeing double digit declines in sovereign yields as well.
At the 10-year tenor, we see the US Treasury yield drop -12.8 basis points. Much in line with European sovereign yield declines.
Confounded Interest - Anthony B. Sanders 
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