by Bryan Perry
March 21, 2023
This past week of volatility in the banking sector was epic, along the lines of how the 2008 crisis began, when some high-profile mortgage lenders and investment banks dealing in risky practices went bankrupt, filed for Chapter 11, or were acquired for pennies on the dollar. To say that the recent events in the regional bank sector (and Credit Suisse) are surreal would be an understatement. Oh, how history does tend to repeat itself – in various forms – but with the same pattern of hubris, greed, and sheer stupidity.
Take Barney Frank for instance. As the co-author of the 2010 Dodd-Frank Act, enacted to prevent the excessive risk-taking that led to the 2008 financial crisis, it appears there is some twisted irony as to how Mr. Frank was a sitting board member of the now-failed Signature Bank that was one of only a handful of banks allowing customers to deposit and transact in cryptocurrency assets 24/7 beginning in 2018.
One can also look at the demise of FTX and Sam Bankman-Fried as the spark that led to the collapse of crypto-centric Silvergate Bank and the further chain reaction that ignited fears of depositors at Silicon Valley Bank and Signature Bank for their exposure to start-ups, crypto, and commercial office space.
From there, the market was taking down shares of banks with large uninsured deposit bases, with First Republic Bank (FRC) being the newest poster child of this brand of contagion. No sooner than one day after 11 banks transferred $30 billion to First Republic to shore up their deposit base, it was reported that top executives at First Republic sold millions of dollars of company stock in the previous two months, so the rally in FRC last Thursday on the rescue plan fizzled Friday on news of the stock sales by insiders.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The other deadly transgression by bank executives was reaching for yields on their bond portfolio by investing in long-term bonds – even though the difference in yields to that of short-term bonds was minuscule – thereby taking a huge risk of principle. When money rained on the bank system from the roughly $4.7 trillion created in pandemic stimulus, banks invested heavily in long-dated government bonds. When the rate on the 10-yr Treasury briefly rose to 1.75% in March 2021, banks rushed to buy.
Going for 1.75% instead of accepting 0.40% on 3-year T-Notes looks quite short-sighted now. At 1.75% for 10-year paper, there is really only one direction yields of that duration can go – higher – and only one direction for long-term bond prices to go – lower. To the extent that these risk managers didn’t ladder their bond holdings borders on reckless, as if inflation from printing trillions of dollars wouldn’t somehow soon arrive. All that risk gets you is a spread of 1.3% between the 3-yr and 10-yr Treasuries.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The obvious question now is how many, and to what extent, are other banks also under water with their bond portfolios, and what is the amount of their uninsured deposits, and their exposure to commercial office space? In recent days, numerous CEOs of small- to mid-size banks put forth statements that what happened at these big banks is unique, in that they engaged in non-traditional activities. They say that “all is well,” and their institutions are safe and sound; yet there is no mention of their Treasury holdings and a maturity schedule, a breakdown of commercial real estate loans, and their level of uninsured deposits.
Transparency is what investors and depositors want most. Banks should immediately make public their current holdings and details of their financials and balance sheets. Warm and fuzzy statements do nothing to shore up confidence. Suspicions arise when banks say, “There is nothing to worry about,” and then don’t supply specific numbers. With first-quarter earnings season approaching, investors will have ample opportunity to investigate the details of each bank during the earnings calls following quarterly results.
The Wall Street Journal reported on the importance of smaller banks on March 19, when they wrote:
“Smaller banks are crucial drivers of credit growth, the fuel that powers the economy. Banks smaller than the top 25 largest account for around 38% of all outstanding loans, according to Federal Reserve data. They account for 67% of commercial real estate lending. The possibility that other banks have similar problems has triggered a selloff of financial stocks as investors scrutinize bank solvency. This, in turn, stoked public alarm about the safety of deposits and the size of unrealized losses.”
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
This week will hopefully begin to provide some much-needed clarity of risks within the wider banking sector. It is widely accepted that lending standards just tightened up for both businesses and consumers in order to raise capital ratios. Additionally, some pundits are suggesting that recent events could trigger a wave of weaker banks being swallowed up by bigger banks to avoid the potential of further bank runs. These mergers could be voluntary, or at the direction of state bank regulatory agencies.
What the market seeks most is a rapid response by the bank industry, the Fed, and Treasury to prevent a further ripple effect. The fact that the Fed and Treasury jointly agreed to guarantee all deposits above the $250K FDIC level of insurance at SVB is fueling a fresh debate about the moral hazard of universal deposit insurance. The potential for unintended consequences is high. If all funds are guaranteed at all levels, there’s at least some incentive to take on higher risks with depositors’ funds to chase profits.
What should come of recent events is that there should be more stress testing with stricter mandates about where capital is concentrated. I think if these directives were made known to markets sooner rather than later, the ground under the banking sector might stop shaking.
Let’s hope sound minds and proper decision making prevail in the days ahead.
Navellier & Associates Inc. does not own Silicon Valley Bank (SVB), Signature Bank, Silvergate Bank, Credit Suisse Group (CS), or First Republic Bank (FRC) in managed accounts. Brian Perry does not personally own Silicon Valley Bank (SVB), Signature Bank, Silvergate Bank, Credit Suisse Group (CS), or First Republic Bank (FRC).
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
Also In This Issue
A Look Ahead by Louis Navellier
The Best and Quickest Ways Out of This Banking Crisis
Income Mail by Bryan Perry
Rapid Transparency Can Quell Any Crisis of Confidence in the Banking Sector
Growth Mail by Gary Alexander
Beware The Ides of March (Part 2)
Global Mail by Ivan Martchev
QE Has Restarted
Sector Spotlight by Jason Bodner
What To Do When You See Red
View Full Archive
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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