Introduction
To HODL, for cryptocurrency and meme-stock enthusiasts, is to “hold on for dear life” through volatility. Following the demise of Silicon Valley Bank (‘SVB’) and Signature Bank, several smaller banks started this week straining to HODL themselves. While the institutions placed into receivership so far had in common a dependence on corporate depositors that made them outliers in the broader banking ecosystem, the problem on the other side of their balance sheet is alarmingly more common.
For although most other banks have a more diversified set of deposit liabilities, many have assets similarly concentrated in “held to maturity” (‘HTM’) bond portfolios. This designation saves the banks from having to mark bond prices to market – a useful characteristic after a period when fixed-income assets have been hit hard by an aggressive rate-hiking cycle – but of course investors can, and do, still make their own calculations of asset values. This can lead to worrying charts like Figure 1, which suggest an unrealised trillion-dollar loss on these portfolios for US banks last year.
In this article, we will consider the extent to which concern is justified for banks in the US, Europe and Japan.
Figure 1. Unrealised Gains and Losses on US Banks’ HTM Securities
Problems loading this infographic? - Please click here
Source: FDIC; as of 28 February 2023.
The US
Figure 1 aggregates all FDIC-insured institutions, but we can also look at individual banks’ HTM performance as a percentage of their Common Equity Tier 1 capital (CET1) in Figure 2 or the impact of this performance on their position relative to their minimum required CET1 in Figure 3.
Figure 2. Mark to Market of Banks’ HTM Securities as Percentage of CET1
Problems loading this infographic? - Please click here
Source: Man Group, Autonomous Research, and S&P Capital IQ; as of 31 December 2022. The organisations and/or financial instruments mentioned are for reference purposes only. The content of this material should not be construed as a recommendation for their purchase or sale.
Figure 3. Impact of Banks’ HTM Securities on Minimum Required CET1
Problems loading this infographic? - Please click here
Source: Man Group, J.P. Morgan, and S&P Capital IQ ; as of 31 December 2022. The organisations and/or financial instruments mentioned are for reference purposes only. The content of this material should not be construed as a recommendation for their purchase or sale.
Figure 3 reveals that several extremely large US banks have, on a market-value basis, breached their regulatory minimum capital levels. That they have not been – and almost certainly will not be – subject to regulatory action should not be taken as a sign that regulators and the FDIC are comfortable with the status quo, in our view. Rather, it seems regulators have no choice but to play for time, with measures like the new Bank Term Funding Program to help provide stable funding. Ironically, the market appears to have taken precisely the opposite view, with larger banks reporting substantial deposit inflows this week.
Banks with such unrealised losses – and lacking Tier 2 or 3 capital – are arguably playing with fire.
That said, banks with such unrealised losses – and lacking Tier 2 or 3 capital – are arguably playing with fire. Regulators are clearly aware of the risks, as evidenced by typically cautious authorities acting so assertively to take over two banks between a Friday and a Sunday. The emphatic response restored a measure of stability to US banks’ share prices later in the week, but many remain materially down. Yet despite our confidence that the largest banks will not be allowed to fail, this doesn’t make suddenly cheaper banks attractive investments for us. The unrealised HTM losses still must be unwound, with capital raises a probable option for regional banks in particular, and we think an eventual regulatory response all but inevitable.
Europe
The picture is slightly different in Europe. As we discussed on Tuesday , the smaller European banks have been subject to more stringent liquidity and capital requirements, and their credit provisioning is already quite conservative. Europe’s deposit flows have been very stable, with banks passing on little of recent rate rises (only 9% of the rate increase versus 35% in the US, and 61% in the European rates cycle of 2005) whilst maintaining deposit volumes.1
There are nevertheless pockets of weakness. Switzerland has a well-known bank going through a restructuring process that makes it vulnerable despite a strong capital and liquidity profile, in our view. In Germany, the Bundesbank has been very publicly focused on the HTM exposure of the co-operative savings banks (essentially, the country’s smaller regional banks). However, these banks are individually small, collectively strong and have extremely diversified deposit bases, so we do not foresee systemic problems arising.
Japan
It’s a similar story in Japan, where some regional banks’ share prices have come under pressure amid their mark-to-market losses on holdings of US bonds. Japan’s banking regulators have long taken an interest in this matter, though, and we have been engaging local banks on their balance sheets for more than a year now. In our experience, management is fairly conservative with these positions, their exposure tends to be low duration, and the vast bulk are “available for sale” and marked to market already. Japanese banks also uniquely have large equity cross shareholdings, and the unrealised gains on those are significantly larger than their unrealised bond losses.
We would instead ascribe the banks’ recent performance to investors exiting what had become a crowded trade in Japanese banks on the expectation of policy normalisation from the Bank of Japan.
Conclusion
The gradual process of resolving these HTM issues may continue to weigh on those worst hit so far.
Overall, we see little evidence that the global banking system is on the brink of collapse, but equally neither do we expect the most-sold banks to begin a sustained rally from here. Rather, the gradual process of resolving these HTM issues – through recapitalisation and tighter regulation in the US in particular – may continue to weigh on those worst hit so far. We will also be monitoring the Federal Reserve’s weekly data on deposits, and money-market flows, for signs of any further pressures building on banks’ balance sheets.
1. Source: FDIC, ECB, Bloomberg and Autonomous Research estimates; as of 14 March 2023.
You are now leaving Man Group’s website
You are leaving Man Group’s website and entering a third-party website that is not controlled, maintained, or monitored by Man Group. Man Group is not responsible for the content or availability of the third-party website. By leaving Man Group’s website, you will be subject to the third-party website’s terms, policies and/or notices, including those related to privacy and security, as applicable.