Banks are in PAIN! About half of U.S. banks (2,315) with $11T of assets have a lower value of their assets compared to the face value of their debt liabilities. The market value of their assets is about $2.2T lower than the book-value accounting.

If half of uninsured depositors decide to withdraw, the losses due to CRE distress would result in up to 58 smaller regional banks becoming insolvent in addition to 186 banks that would become insolvent just due to higher rates.

Wut Mean?:

The U.S. banking system’s market value of assets is about $2.2 trillion lower than suggested by their book-value accounting for loan portfolios held to maturity.

Consequently, about half of U.S. banks (2,315) with $11 trillion of assets have a lower value of their assets compared to the face value of their debt liabilities.

• About half of deposits are uninsured, accounting for about $9 trillion of bank funding in the aggregate.
• If there is a widespread run by uninsured depositors, more than 1,600 banks could fail with aggregate assets of close to $5 trillion.
• The commercial real-estate distress would add up to an additional $160 billion of losses and a $2.2 trillion decline in the value of bank assets due to higher rates.
• While losses due to commercial real estate distress are an order of magnitude smaller than the decline in bank asset values associated with a recent rise of interest rates, they would impact a sizable set of banks.
• Due to these losses, up to 580 additional banks with aggregate assets of $1.2 trillion would have their mark-to-market value of assets below the face value of all their non-equity liabilities.

Remember, higher interest rates put pressure on commercial real estate--especially on deals financed with debt at historically high property values and low interest rates.Many of these loans mature in the next couple of years and some are going to have to try and refinance at much higher rates--the firms on the other end of these loans ARE NOT on a solid foundation to do so:

On top of this, as this month, just half of U.S. workers had returned to the office compared to pre-pandemic levels--paying a ton of money for empty space.

In the first quarter of 2023, the office vacancy rate reached 18.6%, 5.9% higher then the last quarter of 2019.

REITs focused on the office sector declined by about 60% since the beginning of pandemic, implying more than 30% decline in the value of their office buildings.

While the overall delinquency rate on commercial mortgages is still relatively low, it has been quickly rising, especially in the office sector.

For example, PIMCO and Blackstone recently defaulted on office loans.

The Outlook is not good either:July 2023 Senior Loan Officer Opinion Survey on Bank Lending Practices. Banks plan to further tighten lending standards across all loan types:

• Banks tightened standards for all CRE loan categories, with both large and other banks showing similar tightening levels.
• Demand for CRE loans weakened, with other banks seeing a greater decline than large banks. Foreign banks also reported a decrease in demand and tighter standards.
• A majority expect stricter standards for construction and nonfarm loans, with a sizable portion also expecting tightening for multifamily property loans.

Reasons for the expected tightening include:

• Uncertain economic outlook.
• Expected decline in the value of collateral.
• Anticipated decrease in credit quality.
• Reduced risk tolerance.
• Predicted liquidity challenges.
• Concerns about funding costs, deposit outflows* &, and potential impacts of legislative or supervisory changes.

*deposit outflows

Bank Term Funding Program (BTFP):

https://www.reddit.com/r/Superstonk/comments/11prthd/federal_reserve_alert_federal_reserve_board/:

• Association, or credit union) or U.S. branch or agency of a foreign bank that is eligible for primary credit (see 12 CFR 201.4(a)) is eligible to borrow under the Program.
• Banks can borrow for up to one year, at a fixed rate for the term, pegged to the one-year overnight index swap rate plus 10 basis points.
• Banks have to post collateral (valued at par!).
• Any collateral has to be “owned by the borrower as of March 12, 2023."
• Eligible collateral includes any collateral eligible for purchase by the Federal Reserve Banks in open market operations.

Richard Ostrander (one of the architects of BTFP) spoke about it the other day:

When the Federal Reserve established the BTFP, the lawyers of the New York Fed played an important role in facilitating its rapid implementation. I was responsible for coordinating among my team of attorneys at the New York Fed and the Board of Governors to ensure that our actions complied with applicable statutes and regulations.

Over the weekend of March 11 and 12, the Fed designed the BTFP to support the stability of the broader financial system by providing a source of financing for banks with Treasury, Agency and other eligible holdings whose market value had significantly diminished given interest rate increases.

There was not enough time to set up special purpose vehicles as the Fed had done for some of the pandemic programs. The only way to have the program up and running so quickly was to leverage our discount window facilities.

As a result, we turned to Section 13(3) of the Federal Reserve Act, which authorizes specialized lending in unusual and exigent circumstances. The BTFP extends the maximum term of lending from the Section 10B limit of four months up to a special limit of one year. Additionally, unlike traditional discount window operations, the BTFP authorizes banks to borrow against eligible holdings up to their par value rather than their market value less a haircut

The Fed has created an emergency backstop program so that banks won’t have to sell assets into the market if customers pull deposits in search of more attractive yields for their savings....

Over the few weeks prior to the FDIC receivership announcements on March 10 and 12, the banking sector lost another approximately $450 billion. Throughout, the banking sector has offset the reduction in deposit funding with an increase in other forms of borrowing which has increased by $800 billion since the start of the tightening.

The right panel of the chart below summarizes the cumulative change in deposit funding by bank size category since the start of the tightening cycle through early March 2023 and then through the end of March. Until early March 2023, the decline in deposit funding lined up with bank size, consistent with the concentration of deposits in larger banks. Small banks lost no deposit funding prior to the events of late March. In terms of percentage decline, the outflows were roughly equal for regional, super-regional, and large banks at around 4 percent of total deposit funding:

The blue bar in the left panel above shows that the pattern changes following the run on SVB. The additional outflow is entirely concentrated in the segment of super-regional banks. In fact, most other size categories experience deposit inflows.

The right panel illustrates that outflows at super-regionals begin immediately after the failure of SVB and are mirrored by deposit inflows at large banks in the second week of March 2022.

Further, while deposit funding remains at a lower level throughout March for super-regional banks, the initially large inflows mostly reverse by the end of March. Notably, banks with less than $100 billion in assets were relatively unaffected.

However, during the most acute phase of banking stress in mid-March, other borrowings exceeded reductions in deposit balances, suggesting significant and widespread demand for precautionary liquidity. A substantial amount of liquidity was provided by the private markets, likely via the FHLB system, but primary credit and the Bank Term Funding Program (both summarized as Federal Reserve credit) were equally important.

• Large banks increased borrowing the most, which is in line with deposit outflows being strongest for larger banks before March 2023.
• During March 2023, both super-regional and large banks increase their borrowings, with most increases being centered in the super-regional banks that faced the largest deposit outflows.
• Note, however, that not all size categories face deposit outflows but that all except the small banks increase their other borrowings.
• This pattern suggests demand for precautionary liquidity buffers across the banking system, not just among the most affected institutions:

Wut Mean?

• Banks have been replacing deposit outflows with the borrowing we have covered above.
• 'Strong and resilient' indeed....
• It is starting to smell idiosyncratic all up in here:

To me, this is looking more and more like over-reliance on Central Bank Funding!Agencies update guidance on liquidity risks and contingency planning. "The updated guidance encourages depository institutions to incorporate the discount window as part of their contingency funding plans." The liquidity fairy is now ENCOURAGED?Oh yeah, The Fed announces the individual capital requirements for all large banks, effective on October 1. The minimum capital requirement is 4.5 percent; The stress capital buffer requirement is at least 2.5 percent.

Betchya those BTFP numbers jump even more!

Interestingly, the other day the FDIC observed some institutions incorrectly reduced the amount reported to the extent the uninsured deposits are collateralized by pledged assets; this is incorrect as the existence of collateral has no bearing on the portion of a deposit that is covered by federal deposit insurance!:Wut mean?:

• The FDIC noticed that some banks aren't correctly reporting the amount of deposits they have that aren't covered by federal insurance. Some banks mistakenly think that if a deposit is backed by assets (like collateral), it doesn't need to be reported as uninsured.
• This isn't right! The deposit's status doesn't change just because it has collateral.
• Also, some banks were leaving out deposits made by their own subsidiary companies.

Then on Friday, Heartland Tri-State Bank of Elkhart, Kansas, was closed today by the Kansas Office of the State Bank Commissioner, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver.

• with $139m in liabilities and $130m in assets
• Usually you would see bank failures happen when the ratios are way out of wack and they go up-side-down quickly because of the massive liability:asset ratio and paired with lots of leverage.
• However, this was not the case, and yet the DIF still needed to step in and cover over 40% of deposits.
• Speculation: Are they caught up in all of this?
• They had 554,000 CRE loans:

TLDRS:

• About half of U.S. banks (2,315) with $11 trillion of assets have a lower value of their assets compared to the face value of their debt liabilities.
• The market value of their assets is about $2.2 trillion lower than the book-value accounting for loan portfolios held to maturity.
• The BTFP buys another day, but will banks be able to survive October's reserve requirements?

The FDIC noticed that some banks aren't correctly reporting the amount of deposits they have that aren't covered by federal insurance. Some banks mistakenly think that if a deposit is backed by assets (like collateral), it doesn't need to be reported as uninsured.

• Heartland fails shortly after this notice--connected? They had 554,000 CRE loans.
• Reminder, while banks have the liquidity fairy, 'we' get the promise of 2 more rate hikes this year, Atlanta Fed President Raphael Bostic yet again enrichens himself inappropriately from his position.
• To fix one end of their mandate (price stability) from the inflation problem they created, the Fed will continue sacrificing employment (the other end of their mandate) to bolster price stability by continuing to raise interest rates--causing further stress to businesses and households.
• I believe inflation is the match that has been lit that will light the fuse of our rocket.

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