SVB was fortunately only slightly insolvent

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Good morning. Today will be an interesting day in the markets. Have US authorities done enough to address bank run concerns? We feel the same way, but the situation remains tense. Emotion, not reason, can rule the day. Send us your concerns, conspiracy theories and trading strategies at: [email protected] and [email protected]

Silicon Valley Banks (and the US Banking System)

As of last night, there were high expectations that another Silicon Valley bank would swoop in and take the problem out of the FDIC’s hands and protect unsecured depositors. But it seems no deal could be done. At 6:15 p.m. New York time, the Treasury, Federal Reserve and FDIC announced That they were taking matters into their own hands, not just for SVB but for Signature Bank, another lender that recently faced deposit outflows. Both the banks will be resolved and all their depositors, insured and uninsured, will be made whole. Meat of the Declaration:

[All] depositors [in SVB] Starting Monday, March 13, they will have access to all their money. Any losses associated with the resolution of Silicon Valley Bank will not be borne by the taxpayer.

We are also announcing a similar systemic risk exception for Signature Bank, New York, New York, which was closed today by its state chartering authority. All the depositors of this institution will be made whole. ,

Shareholders and certain unsecured debt holders will not be protected. Senior management has also been removed. Any loss to the Deposit Insurance Fund to support uninsured depositors would be compensated by a special assessment of banks

This has been interpreted broadly to mean that the authority will pay uninsured depositors anything from the $128 billion deposit insurance fund that the SVB’s assets cannot cover. However, this statement is a bit unclear to us, and we are still not sure how much bailout it is. Details will come in the coming hours and days. In the case of SVB, however, the fact that the bank was not heavily insolvent is probably a large part of the answer.

Granted, being a little bankrupt in banking is a little like being pregnant, but bear with us. Recall that SVB’s problem was not, as with most failed banks, bad credit burning a hole in the asset side of the balance sheet. Instead, it was a net duration mismatch between deposit liabilities and high-quality bond assets. Ken Usdin’s team at Jefferies presents an analysis whereby, if SVB’s securities portfolio is sold at a 20 percent discount, its debts are repaid at a 2 percent discount, and its creditors and insured depositors are repaid, then Will also be left with $86 billion in cash:

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Jefferies estimates that SVBs now have $91 billion in uninsured deposits left after last week’s move. If this is correct, then the bank is only short by $5bn. Perhaps that gap can be met by leaving some or all of the banks’ other creditors, who are owed some $22bn, out in the cold?

Federal Reserve too announced that it would provide liquidity to other banks facing withdrawals. A “bank term funding program” would see banks offer loans of up to one year, take -backed bonds as collateral, and mark those bonds to market at par, rather than marking them to market.

Will two actions be enough to end the threat of this week’s bank run? In a rational world, they would be. While the rest of the banking system suffers from some of the same malaise that SVB had, the systemic malaise is not as severe.

Sick as a reminder that deposits flooded banks over the past few years and much of that was invested in -backed bonds. Now that rates have gone up, they have a lot of unrealized losses on those bonds. If they were forced to sell those securities (by a bank run, say) those losses would be realized.

Banking system doomsters here on Twitter from Michael Semblest of JP Morgan got a workout in over the weekend. This shows what would happen to the equity capital ratios of various major banks if all unrealized losses on their portfolios were factored out:

Yes, realizing the losses will result in a large reduction in the equity of some banks, as Doomsters pointed out. But note that even if this happens, all banks will still have a solid equity cushion. Even SVB (by the end of last year) would have been solvent, and it had the highest ratio of securities to total assets of any US bank. All other banks in the graph would have been fine under the security portfolio liquidation scenario. And there is no reason to think that any of them would have to sell all their securities, even under extreme circumstances. For one thing, if they need cash, they can do repos instead of selling securities.

That’s not to say that it’s great that banks have all these securities that they bought when rates were low. It stinks for them, and will be a drag on profits for years. But this is not an existential issue.

Most banks still benefit from higher rates, on balances, as their loan portfolios get revalued. Bank of America is a classic example of this. Half a trillion dollars (!) of agency-backed securities held by the bank have fallen in 10 years or more, which is 2.1 percent. In itself, that’s pretty bad! The yield is well below market, and unless rates return to their lows a few years ago, any sale of these things before maturity (which is a long time from now) will generate a huge loss. But zoom out: The bank also has a trillion dollars in loans that pay more interest as rates rise. It also has half a trillion dollars in cash and reserves to meet withdrawals or invest at higher rates. SVB sinking higher rates help Bank of America.

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There are regional banks that aren’t in nearly so good shape – their names were kicked out this weekend – but as we’ve argued before, no bank was as vulnerable as SVB, given its rate-sensitive Dominated by long bonds with a combination of business deposits and asset portfolios. It would be a shame if, despite regulators’ actions on Sunday, there was still panic in the banking system this week. It wouldn’t make any sense.

jobs report

Friday’s February jobs report would have been confusing even if the bank hadn’t failed on the same day. The data jitters included a consensus-busting 311,000 new jobs, offset by slowing wage growth, and a rise in unemployment, but driven by an improved labor force participation.

But because one bank failed that day, the market reaction to the report is difficult to read. More broadly, investors fled to safety: Returns fell as stocks fell. Futures markets priced in a rate cut in December (again). Yet market watchers disagreed on whether the reaction was short-term panic or a sensible revision of rate expectations. Christian Keller at Barclays sums up the failure of the SVB and the number of jobs lost in protest:

If Powell’s comments set the stage for the middle of the week [for a 50 basis point hike this month]Friday’s non-farm payrolls numbers should have sealed the deal. , ,[leaving]3 month average [payroll] Gains at 351k – too hot of a labor market for the Fed’s comfort. True, average hourly earnings (AHE) growth slowed to 0.2% m/m (versus 0.3% m/m expected) [but the] The measure is notorious for lacking controls for composition (i.e., increasing employment in low-wage service industries). March meeting with more conviction.

However, from the financial sector at the end of the week complicates this call. , , As the news developed, after surging well north of 50% following Powell’s testimony, US bonds rallied on safe-haven demand and funds futures expected to move 50bp below 50%.

Taking the other side, Phoebe White of JP Morgan argued on Friday that “an improvement in the labor supply and easing wage inflation should take some of the pressure off the Fed”. The dash-for-safety related to SVBs, White writes, came despite “little risk to market contagion or widespread fire-selling,” suggesting that markets will soon refocus on monetary policy, particularly After falling consumer price inflation data this Tuesday.

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How to analyze it? Here’s how we weave the facts together.

Contra Keller, we would argue that the trend of slower wage growth is a meaningful disinflationary signal, and in itself is more relevant to inflation than strong jobs growth. It also fits in with companies reporting this quarter that hiring is getting easier. Yes, payroll data can be noisy from month to month, but the guts of the recent data don’t suggest dire distortions. As noted by Inflation Insights’ Omar Sharif, eight of the 13 measured areas experienced the slowest wage growth in the past three months, indicating that the February data is signal, not noise. The broad trend is very clear:

Line chart of annual wage growth indices, showing no wage spiral

is white Perhaps Admittedly, SVB flight-to-safety has gone into overdrive – especially now that the has intervened. Even in the absence of a bank run, SVB disturbances can have long-term effects on Fed policy and markets.

Consider Powell’s public testimony last week, in which he put the swift pace of rate hikes back on the table. That instrument – ​​the pace of growth, as opposed to the peak rate – will be most affected by near-term economic data, including jobs data and whatever the CPI shows this week. SVB probably won’t affect it one way or the other. But over time it could affect the Fed’s higher-long-term policy stance, as it tightens on a timer. SVB’s double decker bets at perpetually low rates had a idiosyncratic flair. But the strict policy will soon expose other follies, the nature of which we can only guess. They will hurt the economy, as has already happened with SVB. And the more things break, the less sustainable the high-end will be in the long run. ,ethan wu,

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