Saving Mr. Banks

Saving Mr. Banks

Admiral Boom: “How’s things in the world of finance?”
Mr. Banks: “Never better, money’s sound, credit rates are moving up, up, up, and the British pound is the admiration of the world.”

Let’s say you’re the CEO of a fairly large regional bank. The past two weeks have been a slightly harrowing experience for you. After all, banking is like airplane piloting: years of boredom, seconds of terror. And in that terror, there’s probably three things top of your list:

  1. Your AT1s likely ain’t worth the whiskey – after the Credit Suisse/UBS shotgun marriage where AT1s were wiped out and shareholders spared, any plans you might have had to issue more in this economy need to be re-thought
  2. You’re going to be taking some very hard looks at (a) how many depositors you have that are above the $250,000 insurance limit, and (b) could you, Standard Regional Bank Inc., passably appear ‘systemic’ enough to receive support to guarantee those uninsured depositors should Bad Things Happen?
  3. And while you’re doing all of this, you’re likely receiving a lot of calls from shareholders, regulators, the press about your available-for-sale and held-to-maturity portfolios, just in case it looks like Standard Regional Bank is the one to make the Bad Things Happen?

Problem 1 is fundamentally an issue of what it means to be a bank creditor when the regulator can (within reason) say “yes this is what would normally happen, but banks aren't normal. We need those to, you know, keep society going.” There has been plenty written already about what the subordination of AT1s to CS shareholders means or doesn’t mean for the banking system at large but it poses an important question for future banking bond investors: what is the functional difference between liquidity and solvency and how is that likely to play out in the future?

Problem 2 is one we touched on last week and is largely a Know Your Customer issue. SVB had an idiosyncratically large depositor base of customers well above the guaranteed 250K limit. Combine that with long-dated exposure and... well you know. The impact for regional banks now is in some ways a structural and political one – the less likely you are to be seen as systemic or at least ‘one of the good ones’, the less likely your uninsured depositors will be saved and the more reason they have to leave for your larger competitors. The good news is that the pressure seems to be easing. Debt issuance by the Federal Home Loans Bank (aka the lender of next to last resort) has slowed sharply and overall usage of the Fed lending facilities has stayed steady. Regional banks may be out of the woods for now but at a MTD 37% drop in the S&P Regional Bank Index, it’s unlikely to be business as usual for a while…

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Problem 3 is where it gets really interesting for me. At the end of last week, held-to-maturity bank portfolios were rightly top of mind (for us and for others). But in focusing on the HTM book, are investors missing other risks and punishing the wrong banks?

In the words of my colleague Alan Bowe:

If banks are going to be criticised for taking interest rate risk, they should also be given credit for the value of their deposit franchise.

The old joke about banks in crisis is that the left side of the balance sheet has nothing right, and the right side has nothing left. A bank’s deposit franchise is crucial to the overall picture of a bank’s strength but it’s not part of the balance sheet for accounting purposes. Equity investors appreciate this as a bank with a larger, sticky deposit base can benefit future profits. But to many investors, it’s a pox on all their houses.?

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The difference between the US and the EU in the example above is telling. Where in the US, money market funds are much more common to get a higher interest rate, the European capital markets structure is less developed. European banks are also more tightly regulated and have already deducted the losses on their available for sale portfolios. This can lead to bit of tricky situation for investors and their risk teams. On the face of it, smaller US banks look like they have better capital ratios sure than the Europeans. But once you factor the AFS losses, it gives a clearer view of what kind of risks they’re actually siting on.

All this is to say, there’s probably more to the banking picture than “big HTM portfolios are bad”.

But hey, it could be worse. You could have just bought a big bag of rocks thinking they were nickel.

Christian Hille

Founder and CEO of Caplign Wealth. Experienced Finance Professional and Investor

1 年

Very good summary and point of view Steven Desmyter . One comment: the Swiss CS AT1 terms are different (in their jurisdiction) and hence actually allow to be set to zero in case of government intervention. That this doens’t make any sense, when equity holders receive more, is another point.

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