WSJ: Banks’ Problems Aren’t Over, According to the Bond Market

Old_Joe

Following are excerpts, heavily edited for brevity, from a current Wall Street Journal report:

Moody’s [downgraded] the credit ratings of 10 banks and put others under review, or giving their ratings a negative outlook. Credit ratings are very important for banks, which fund themselves partly with deposits, but also by selling bonds.

But the ratings moves are a reminder that many of the core issues revealed by the crisis this year—such as the risks posed by higher interest rates—are only beginning to be addressed. And one risk that investors can’t afford to ignore is that longer-term interest rates could keep pushing higher, even as the Federal Reserve looks to be pausing its rate hikes.

However, Moody’s also wrote that it saw some key issues unaddressed by the Fed’s thousand-plus-page proposal.

Moody’s analysts acknowledged in their Monday report that the Fed’s tougher capital requirements for banks with over $100 billion in assets should be positive for their credit risk, [but also said] that interest-rate risk is “significantly more complicated” than that. For example, there is the diminished value of loans like fixed-rate mortgages—a huge problem for First Republic, for one. In its analysis, Moody’s applied a 15% haircut to the value of banks’ outstanding residential mortgages.

The bond market’s focus on worst-case scenarios may explain the gap between the performance of many lenders’ debts versus their shares. In theory, higher capital requirements coming for many banks ought to provide more comfort for bondholders, who focus more on existential risk, than shareholders, who should be worried about the drag on banks’ returns on equity from higher equity levels.

But this security cushion isn’t what markets appear to be reflecting. Across regional banks with A ratings, though their bonds have rallied in recent weeks, investors are still demanding a lot more return to own them than they were prior to SVB’s collapse. The gap between those banks’ senior bond yields versus Treasurys was still about 50% wider than on March 8 as of Monday.

It is a relief that banks have found a number of ways to stabilize their earnings and rebuild some capital, but bond market jitters show there is still a lot more work to be done.

Note: text emphasis in above was added.

Old_Joe

"However, Moody’s also wrote that it saw some key issues unaddressed by the Fed’s thousand-plus-page proposal."

How the heck could a "thousand-plus-page proposal" leave anything "unaddressed"?

yogibearbull

The Fed is stressing capital requirements. But that hasn't been the real problem.

The problem of unstable deposits in this smartphone & Internet-rumors era is not really quantifiable. Bank runs now develop in hours/days, not months.

One can generally say that brokered deposits may flee before the other deposits. The Fed hasn't developed good indicators for this yet. I think that it is now requiring disclosure of % of total deposits that are brokered deposits. BTW, brokered deposits are quite expensive for the banks (they have to pay platform fees to list brokered deposits, and then you see high rates that are net of those hidden costs). There is something wrong with a bank that relies primarily on brokered deposits.

The Fed is also using some ad-hoc liquidity tests.

Old_Joe

"There is something wrong with a bank that relies primarily on brokered deposits."

Yes, it would certainly seem so. I don't think that we, as purchasers of those brokered CDs, can realistically find enough accurate information to have any idea of the actual stability of any given bank offering brokered deposits.

That means putting a lot of faith in the FDIC. It's also why I mentioned, in the "CD Rates Going Forward" thread, using multiple CDs in smaller amounts at multiple banks for any step in a CD ladder, rather than having one large CD in any one bank. Spread the risk- it's worth the small amount of extra bookkeeping.

It's also an argument for using Treasuries when possible.