Here Are The Banks Facing The Highest Deposit-Run Risk
Here Are The Banks Facing The Highest Deposit-Run Risk
Zero Hedge
BY TYLER DURDEN
SUNDAY, MAR 12, 2023 - 02:35 AM
Earlier today, hedge fund manager Bill Ackman tweeted something (very long) which despite being traditionally self-serving (who can forget Ackman's "hell is coming" tearful CNBC appearance which meant to spark panic, chaos and more selling... not to mention a $2BN payout to Ackman), was also correct:
Absent JPMorgan, Citi or Bank of America acquiring SVB before the open on Monday, a prospect I believe to be unlikely, or the gov’t guaranteeing all of SVB’s deposits, the giant sucking sound you will hear will be the withdrawal of substantially all uninsured deposits from all but the ‘systemically important banks’ (SIBs). These funds will be transferred to the SIBs, US Treasury (UST) money market funds and short-term UST. There is already pressure to transfer cash to short-term UST and UST money market accounts due to the substantially higher yields available on risk-free UST vs. bank deposits. These withdrawals will drain liquidity from community, regional and other banks and begin the destruction of these important institutions.
While we generally disagree with most things Ackman says, his point here is spot on as we explained on Thursday before the sudden and shocking failure of Silicon Valley Bank.
Before we proceed, a quick note again on what is increasingly a moot point: the distinction between SVB and the rest of the banking system. Instead of rehashing what we have said previously (here and here), here is a quick summary from Kroll (full note available to pro subs):
SVB specializes [ZH: well, specialized] in providing banking services to technology-related start-ups. For years as interest rates were at the zero lower bound, these tech start-ups had cash coming in by the truck load from “liquidity events” such as IPOs, secondary offerings, SPAC fundraising, venture capital investments and acquisitions. Many of them deposited their cash at SVB.
Most commercial banks operate by taking deposits (short-term borrowing) and extending loans (long-term lending). SVB was taking in deposits, but it didn’t extend many loans. This was in part because new tech start-ups don’t tend to have the kind of fixed assets and reliable cash flows that make for solid, high-quality borrowers. And it was partly because cash was being handed to them hand over fist from investors in a zero-rate environment.
SVB could have kept the deposits in Fed reserves or Treasury bills, but they paid relatively little. So instead, the bank bought longer-dated, typically safe assets like Treasury bonds and mortgage-backed securities.
When interest rates were at zero, tech start-ups could promise to spend years building AI/machine learning/flying taxis/robots to take care of the elderly and then make a lot of money far in the future, and that was an attractive business proposition. When interest rates rose, a dollar today became better than a dollar tomorrow, and so investors started demanding cash flows. As the Fed hiked rates, the cash being thrown at tech start-ups dried up.
Instead, tech firms had to take their money out of the bank to pay for rent and salaries. SVB’s deposit base fell significantly over the course of 2022. Instead of having its assets tied up in loans (which broadly tend to have floating exchange rates and shorter terms), SVB held bonds (which broadly tend to have fixed interest rates and longer terms). Fixed-rate securities accounted for 57 per cent of SVB’s assets, compared with 27 per cent at Fifth Third and 31 per cent at Bank of America. The average maturity of SVB hold-to-maturity bonds was 6.2 years at the end of 2022.
To redeem client’s deposits, SVB had to sell assets at a big loss. As clients worried about the stability of SVB, they rushed to yank their own deposits, starting a bank run. Unrealized losses snowballed and “completely subsumed the $11.8 billion of tangible common equity that supported the bank’s balance sheet,” meaning that SVB was technically insolvent. The California Department of Financial Protection and Innovation took possession of SVB and appointed the FDIC as receiver, citing inadequate liquidity and insolvency.
Illustrating SIVB's unprecedented reliance on securities is this table we first showed yesterday.
As a result of SIVB's asset exposure, the bank faced another potentially catastrophic toxic feedback loop: as rates rose, the amount of unrealized losses on the banks assets, both its Available for Sale and Held to Maturity books...
... also rose sharply, to the point where, as noted yesterday, SIVB's total unrealized losses (roughly $16BN) had wiped out the bank's entire book value (also ~$16BN).
But while the table does confirm that when looked from the prism of its assets SIVB was truly somewhat of an outlier, the same can not be said when looking at the bank in the context of liabilities, or its funding picture. Here, the key thing is that if a total of $195.5BN in total libilities, $173BN were deposits, a number which shrank by $42BN in just hours on Thursday after several prominent Venture Capital icons told their portfolio companies to pull their money, resulting in a negative $1BN cash balance at the close of business on March 9, pushing the bank into insolvency as full-blown bank run emerged (for details, read this).
Now, where SIVB is not at all different at all from its regional, small bank peers is its reliance on deposits, which is largely due to the Fed's reserve draining QT. Meanwhile, large banks such as JPM, BofA and Citi are still flooded by Fed reserves and have little need for deposits to fund themselves. We said as much in a brief twitter thread today.
This is a point we discussed extensively in "Why Small Banks Are In Big Trouble: As Hedge Funds Pile Into The New "Big Short", The Next 'Credit Event' Emerges", an article we published earlier this week, when we first showed the following chart from TS Lombard showing the gaping divergence in reserves between small and large banks.
But wait, one can counter, clearly nothing has changed dramatically in just the past few days as all the trends observed into last week were clearly present. Unfortunately, that's not true, and what took to wake up the collective consciousness to the gaping asset liability mismatch among small banks was SIVB's mangled announcement it was in a liquidity crisis and was selling its AfS Treasury book and was scrambling to raise capital (it failed to do so, and then failed as a bank).
At that moment, what was on nobody's radar screen, namely the gaping hole in unrealized losses across the banking sector suddenly exploded on everyone's radar screen, and the immediate results was the blitz bank run that destroyed Silicon Valley Bank in hours.
But now, as Bill Ackman correctly warns, the realization spreading across the population that deposits at small banks are facing losses unless the government steps in and somehow backstops these funds ahead of the market open on Monday, means that most banks are subject to bank runs.
It's not just Ackman though. As Kroll also writes in its SIVB post-mortem, incidentally paraphrasing what we said in Why Small Banks Are In Big Trouble, "the bad news is there are other small, community banks that could face bank runs and insolvency. The risk of this is much higher if uninsured depositors of SVB aren’t made whole and have to take a haircut on their deposits. I expect the Fed would insist that any bank purchasing SVB make all creditors whole. If not, businesses will recognize that their uninsured deposits could vanish overnight and will pull their money from smaller community banks and put them in the larger institutions."
So which banks are most exposed? To answer that question we created several charts, starting with banks in the KBW Bank Index (ticker BKX) broken down by deposits as a % of liabilities, or which banks have the highest exposure to external deposits and are thus most at risk to depositor flight.
What is clearly shown is how the "Big 4" banks - JPMorgan, BofA, Citi, and to a lesser extent, Wells Fargo - have far less deposit exposure compared to all other US banks, which is partly thanks to their funding diversification and largely courtesy of their massive legacy excess reserve holdings.
The emerging picture is that while large banks are largely immune from a bank run (unless there is a full-blown financial collapse which will force the Fed to respond even more forcefully than March 2020), smaller and regional banks are fair game, as we, Ackman and Kroll warn.
To isolate those banks in danger, we then looked at the constituent in the KRE regional banking ETF (and cut off those smaller than $20BN), where we did a similar analysis, asking how exposed to deposit flight are the various small banks? We did this by sorting banks in terms of their total deposit/liability exposure. Here is the result. Note, again, that SIVB (shown in red) is hardly an outlier here, and yet as events in the past few days ours have shown, once a bank run emerges it can liquidate a bank in just a few hours.
Finally, since bank runs are an absolute, not relative, event, one where every dollar matters, we have rerun the analysis to show which banks have the least outflow space, by ranking the universe in terms of total liabilities less total deposits. Once again, SIVB ranks in the relatively safe quadrant. Safe, that is, until Thursday's bank run drained $42BN in hours and pushed the bank into insolvency.
There is another way to quantify banks' exposure to deposits and that is via "deposit beta." We won't dwell too much on this topic in this post as it is if secondary importance, but what it shows is how "eager" banks are to pass on rate hikes to depositors. Those with the lowest betas are the ones whose depositors stand to benefit the least from rising rates, and are thus most at risk of seeing depositor flight. Here is a summary from the NY Fed's Liberty Street Economics blog:
Deposits make up an $18 trillion product category that is critical to the funding structure of banks and a key source of savings for households and businesses. The degree to which changes in the target fed funds rate pass through to deposits is important for bank funding, monetary policy transmission, and depositors’ finances. The deposit beta is the portion of a change in the fed funds rate that is passed on to deposit rates. For example, if the target fed funds rate is raised by 50 basis points and in response a bank increases its deposit rate 25 basis points, the deposit beta is 50 percent. In a rising rate environment like the one we are currently in, low deposit betas boost bank earnings but limit payouts to depositors.
Bank of America has a handy cahrt of depositor betas among large-cap and mid-cap banks. We will have more to say on this topic in a subsequent post.
So what is the take home message? To paraphrase what we said before, small banks (but not big ones) are suddenly facing existential risk not just due to the asset side of their balance sheet (where sharply higher rates have led to massive unrealized losses) and where exposure to such assets as commercial real estate/office buildings assures a lot of pain for years to come, but mostly due to liabilities, where the risk of a "contagious" bank run following the SVB failure is now non-trivial as Ackman and Kroll both attest.
Ok, but what's the big deal? Let them fail, do you want even more moral hazard on your hands after the disaster that was the 2008 bailout?
While that is the standard response, it's unfortunately not that simple and the problem is that while a bank run would obliterate the small, regional banks across the US - the ones controlled not by major corporations but hard-working US citizens - it would only make the big banks even bigger and stronger. In other words, the nuance is that while the 2008 bailout was of everyone, a bailout in 2023 would be only of small and regional banks.
That's what we said earlier today (and is why JPMorgan was actively seeking to poach SVB depositors knowing it was effectively contributing to the bank run), that's what David Sacks also argued on twitter today when he said that "the US banking system is on the cusp of being concentrated in a handful of politically connected “too big to fail” banks. One wonders if that’s the point" (paraphrasing what we said last night)...
... that's what David Marcus, CEO of Lightspark tweeted when he said that "not finding a suitable buyer over the weekend will result in much greater concentration in GSIBs than letting one buy it, and this will happen across industries as businesses and people move balances out of smaller banks in fear the same thing will happen to them. Do the right thing. Protect deposit holders while you still can!"
... that's what Kroll wrote in its note today, hinting that a small bank crisis is what the Fed may have been intending all along (full note available to pro subs here)...
Regulation put in place after the global financial crisis was in theory supposed to prevent bank runs like this. The Basel III Accords were supposed to limit banks borrowing short to lend long. But when the Federal Reserve implemented Basel III in October 2020, it only applied to large, internationally active banks. Most jurisdictions apply Basel III to their entire banking system, but the U.S. has a powerful community bank lobby. Consequently, only the big, international U.S. banks are subject to liquidity coverage ratios and net stable funding ratios.
The good news is it is unlikely an SVB-style bankruptcy will extend to the large banks that do have to ascribe to the Basel III rules. The bad news is there are other small, community banks that could face bank runs and insolvency
... and that's what Ackman said too:
I think it is now unlikely any buyer will emerge to acquire the failed bank. The gov’t’s approach has guaranteed that more risk will be concentrated in the SIBs at the expense of other banks, which itself creates more systemic risk.
Yes, but in the meantime, a world with far fewer small banks means far more profits for the large remaining banks. Which, as David Sacks above muses "one wonders if that's the point." The market didn't: with all bank stocks tumbling on Friday, guess which stock was solidly in the green.
The good thing is that we won't have long to wait to get some resolution: if by Monday market open there hasn't been some adequate backstop of uninsured depositors at SVB (whether via government bailout or a bank acquisition or some combination of both), it is almost assured that small banks - especially those overly reliant on deposits for funding - will suffer some form of bank run as depositors pull their money from the bank and put it under the mattress, or purchase non-fiat alternatives (precious metals, crypto, etc). At that point the bank crisis will only get worse, and will accelerate and escalate until the big banks themselves get dragged in. At that point the Fed - and the US government - will have no choice but intervene.
More information available to pro subscribers in today's SVB folder.
