The Next Domino

“You have this complex relationship between solvency and liquidity, and management quality,” said Joseph Mason, professor of finance at Louisiana State University and former senior economist at the Office of the Comptroller of the Currency. “Think of solvency, or decreased equity, as susceptibility to a run. And if a bank is weak financially and if they experience a deposit outflow, they’ll die.” 

A loss of both customers and confidence was the principal cause in the failures of Silicon Valley Bank (SIVBQ) and Signature Bank (SBNY) — two U.S. regional banks that were taken over by the federal government earlier this month  —  and the purchase of Credit Suisse  —  one of the largest banks in Europe  —  by rival UBS for $3.25 billion on March 19. After losing nearly 70 percent of its stock market value last week, First Republic Bank was in danger of also failing  until it received unused liquidity injections totaling $100 billion from a consortium of banks led by JPMorgan Chase (JPM) and the Federal Reserve on March 16. 

Treasury Secretary Janet Yellen sought to calm markets Tuesday by reiterating the federal government’s commitment to ensuring depositors’ savings remain safe amid a government takeover, even if they exceeded the FDIC threshold of $250,000. 

“Our intervention was necessary to protect the broader U.S. banking system,” Yellen said. “And similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion.”

It’s unclear whether Yellen’s words or actions have stemmed the tide of customers fleeing regional banks. 

The stock value of PacWest Bancorp of Beverly Hills, Calif. fell 10 percent on Thursday – despite the bank announcing it secured $1.4 billion in cash the day before. The bank has seen $6.8 billion in customer withdrawals at PacWest, equal to 20 percent of its total, just since the start of 2023.

Joel Naroff, president of Naroff Economics and a former chief economist for several regional banks, notably First Fidelity and TD Bank, described the current environment as “an old-fashioned crisis of confidence,” with both customers and banking executives alike unsure of where the next liquidity challenge might emerge in a fragile global financial market. 

“The problem is most depositors don’t even know how to find out what the risk is at the bank they’re banking with,” Naroff explained. “They don’t know how to read the balance sheets or a 10-K. They don’t know what’s going on.” 

One element of banks’ balance sheets that has become increasingly important to understand is the amortized totals of held-to-maturity (HTM) securities, debt securities purchased with the intention of being held long term, like 10-year or 30-year Treasury bonds, or government-backed mortgage bonds. These HTM securities can be excluded on balance sheets as unrealized losses from bank equity so long as banks don’t sell them before maturity. 

What makes these HTM securities particularly important is their vulnerability to rising interest rates. During a period of low interest rates, it makes sense to invest in them, as these securities are unlikely to be sold at a loss. But the Federal Reserve brought the benchmark Federal Funds Rate to a range of 4.5 percent to 4.75 percent in December.  

“Treasuries are great because there’s no credit risk, but they have the same price risk as any asset,” Naroff explained. “The price risk in 1- or 2-year Treasuries isn’t that great, but when you go further than that you pick up significant price risk.”  

Silicon Valley Bank paid dearly for this price risk. The deceased California-based lender held amortized totals of $91.3 billion in HTM securities, or roughly 43 percent of its $211 billion in total assets, according to the firm’s 2022 10-K. These long-term securities fell in value once interest rates rose last year, forcing Silicon Valley Bank to sell them at a loss of nearly $2 billion, an accounting admission that caused wary depositors to run for the exits beginning March 9. 

“SVB’s money was so heavily concentrated, and there were so many large depositors in there, it didn’t take much when there was any question about the stability of the bank to get the depositors to run,” Naroff said. 

The ratios of amortized totals relative to total assets at other U.S. banks are high but not nearly at the same level of Silicon Valley Bank. 

For instance, the beleaguered First Republic Bank, a regional bank based in San Francisco that is seemingly still fighting for its life amid liquidity pressures, designated $28.8 billion of its assets as HTM debt securities, roughly 13 percent of its $212.6 billion in total assets, according to the firm’s 2022 10-K. Zions Bancorporation, a regional bank headquartered in Salt Lake City, carried $13.4 billion in HTM securities on its books, roughly 15 percent of its total assets of $90 billion, a vulnerability the firm appeared all too aware of, according to statements made in its 2022 10-K:  

“Most components of our balance sheet are sensitive to rising and falling rates, and mismatches in rate sensitivity between assets and liabilities may result in unanticipated changes in both asset and liability values and related income and expense,” Zions Bancorporation said in the introduction to its annual report. 

It’s not just the regional banks that have gone heavy into long-term debt securities. Some of the largest banks in the country carry relatively large positions of HTM securities on their books. 

Bank of America (BAC), with more than $3 trillion in total assets, carried $632 billion in HTM debt securities at the end of last year, or approximately 21 percent of total assets, according to its 2022 annual report. Wells Fargo (WFC), with $1.9 trillion in assets, carried $297 billion in HTM debt securities by Dec. 31, 2022, approximately 15 percent of its total assets, according to its 2022 annual report.  

By comparison, HTM debt securities made up roughly 11 percent of total assets at JPMorgan Chase and Citigroup (C), according to their respective annual reports. 

This large percentage of HTM securities assets has impacted the balance sheets at Bank of America and Wells Fargo in other significant ways: Bank of America carried gross unrealized losses – the amount lost on securities purchased but not yet sold – of $113 billion at the end of 2022, while Wells Fargo held outstanding gross unrealized losses of $49.8 billion for the same period, according to the firms’ respective annual reports. 

At a combined $162.8 billion in gross unrealized losses, Wells Fargo and Bank of America contributed to roughly a quarter of the $620.4 billion total unrealized losses on available-for-sale securities and held-to-maturity securities from 4,706 commercial banks the FDIC studied in fourth quarter 2022. 

By comparison, the gross unrealized losses in 2022 at JPMorgan Chase and Citigroup were $47.9 billion and $31.9 billion respectively, according to annual report data. 

“The combination of a high level of longer-term asset maturities and a moderate decline in total deposits underscores the risk that these unrealized losses could become actual losses should banks need to sell securities to meet liquidity needs,” FDIC Chairman Martin Gruenberg said during a Feb. 28 speech. 

It’s not just the long-term-debt to total-asset ratio that banks and their consumers need to worry about. 

The recent bailouts by the Treasury and Federal Reserve of U.S. regional banks have turned attention to the $250,000 threshold the FDIC has used to guarantee customer deposits since the 2008-2009 Global Financial Crisis (GFC). 

For many U.S. banks, including larger, too-big-to-fail institutions like Bank of America to the tiny regionals like First Republic, a significant portion of their deposit base exceeds the $250,000 recovery limit. 

“In a situation with Silicon Valley Bank, it’s not that the money was going out quickly, but it was easily moved because the concentration of uninsured deposits was so high,” Naroff explained. “Any risk to a bank is that it becomes incumbent on the uninsured depositors to get the money out as soon as possible.” 

Bank of America estimated that $617 billion (32 percent) of its $1.9 trillion in deposits were uninsured, according to its 2022 annual report. 

Wells Fargo estimated $510 billion (37 percent) of its $1.38 trillion in deposits were uninsured, according to its 2022 annual report. 

First Republic’s uninsured rate is much higher than either megabank. First Republic reported that estimated uninsured deposits totaled $119.5 billion, or roughly 67 percent of its $176.5 billion in total deposits, according to its 2022 annual report. 

Three other regional banks in the news lately carried uninsured deposit ratios that exceeded total deposits on their books at the end of 2022.  

Zions Bancorporation carried $38 billion in uninsured deposits on $71.6 billion total deposits (53 percent); PacWest Bancorp carried $17.8 billion in uninsured deposits on $33.9 billion total deposits (52.5 percent); and Western Alliance Bancorporation of Phoenix carried $29.5 billion in uninsured deposits on $53.9 billion in total deposits (55 percent), according to the firms’ respective annual reports. 

By comparison, before Silicon Valley Bank failed, it carried $155 billion in uninsured deposits on $173.5 billion in total deposits (89 percent), according to the late bank’s annual report. 

Professor Mason believes the federal government has stepped into a pickle now that it unequivocally guaranteed the uninsured deposits at both Signature Bank and Silicon Valley Bank. 

“I think the FDIC might’ve gotten themselves between a rock and a hard place,” he said. “Now there’s depositors that have full coverage, but will they have that full coverage if they go to another bank?” 

Mason noted that different banks will value the loans made to individual depositors and businesses differently than their initial, parent institution following a takeover or merger. 

With the Federal Reserve raising interest rates this week — a period of heightened liquidity and confidence concerns, no less — one section of the bank balance sheets that bears monitoring is the loan portfolio for commercial real estate. 

Wells Fargo carried $152.8 billion in total commercial real estate mortgage and construction loans at the end of 2022. Bank of America held a lower number on its books, with $79.2 billion in commercial real estate and commercial lease financing loans at the end of 2022. 

Many of the regionals listed above filled the void of commercial real estate lending during a period of high interest rates and tight credit. 

Zions held $12.7 billion in commercial real estate loans on their books, approximately 23 percent of the firm’s total loan portfolio; Western Alliance Bank carried $15.1 billion in commercial real estate owner-occupied, non-owner occupied, and land and construction loans, approximately 29 percent of the firm’s total loan portfolio. 

But real estate builders, investors and owners should breathe easy, according to Michael Walden, professor emeritus of economics at North Carolina State University. Walden doesn’t see any sort of full-scale crisis like the financial system experienced 15 years ago, even if interest rates rise.  

“While there may be more bank losses as well as bank buyouts, I expect the situation to be contained and not turn into a national ‘meltdown’ as in 2008,” Walden told CO. “The various backstops to the banking system were swiftly used, and thus far there appears to be buyers for large banks that have faltered.” 

Brian Pascus can be reached at bpascus@commercialobserver.com