Looming Liquidity Crisis

Clickbait title. But, I just learned about 12 CFR 1266.4(b). Banks with negative tangible capital have no access to new FHLB advances. Could be an issue for anyone with significant AFS investments due to all the unrealized losses floating around in AOCI. Not an issue for the big boys though, I believe most of them designate investments HTM instead of AFS.


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I thought that this was going to be about the drought.

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The regulation prevents FHLB banks, which fund most community bank mortgage production and contingency funding plans, from issuing new funds to banks that have negative “tangible” capital.

Community banks are experiencing dramatic upticks in unrealized investment losses due to the rapid rate increases. This is significantly reducing their “tangible” capital, and a few have actually broached negative tangible capital. The calculations for tangible and regulatory capital are different, so these banks “should” be fine. But deposit growth is slowing and even starting to reverse, which will limit their ability to fund profitable assets without FHLB access.

So for my dumb ass that doesn’t know much about financials, if I had a million bucks lying around, what would I do in this situation? Short some particular community banks with high exposure to sub prime or some ■■■■? Or some particular end markets that are most dependent on loans from these banks, which I’m assuming are in construction or some ■■■■?

Shorting now would be presumptive. It won’t be a significant issue for most small banks unless several things come together to cause a perfect storm. (1) the Fed Funds rate reaches 4-4.25%, (2) core deposit run-off accelerates, causing a return to pre-pandemic liquidity levels, and (3) some sort of market event (or poor management) leads a bank to have dangerously low on-hand liquidity and activate their contingency funding plan.

This is noteworthy because for most small banks, FHLB funding comprises 80-90% of their planned emergency liquidity, with correspondent lines of credit / Fed Funds Sold making up the remainder.

There’s a website that scrubs individual bank call reports for a lot of financial data. I can’t remember the name of it at the moment though.

The bigger takeaway at the moment is probably for M&A. Credit unions and midsize banks have been snapping up small banks for the past several years. With the investment portfolio depreciation driving down tangible capital, will buyers be willing to pay what sellers want for what the sellers perceive as a temporary equity decline? I know of at least 1 bank purchase deal that collapsed this summer because of it.

Rising interest rates are forcing some community banks to make market adjustments that could restrict funding from the Federal Home Loan banks, prompting some bank trade groups to warn of a potential liquidity crisis going forward. Roughly 100 community banks are expected to report negative tangible capital on call report data that is due at the end of October, experts said.” American Banker says some community banks “could lose access to mortgage advances from the Federal Home Loan Bank System because of rising interest rates and a quirk in the way the Federal Housing Finance Agency determines eligibility for advances.” The piece explains that the “issue is complicated by the fact that the FHFA follows generally accepted accounting principles, known as GAAP, while prudential regulators use regulatory accounting principles. It is far from clear whether prudential regulators — including the FDIC, the Federal Reserve and the Office of the Comptroller of the Currency — will agree to waivers that would allow a bank with negative tangible capital to tap Home Loan bank advances.”

Just call me Mr. Burry (just kidding… probably).

Bigger banks are putting off stock buybacks, so it may be a good time to get a long position in a few of those. Also reduced M&A activity, so smallish publicly traded banks with significant depreciation but low past due loan levels may be attractive targets once depreciation begins to roll off.

You can find portfolio depreciation and past due info pretty quickly on call reports / uniform bank performance reports (ubprs) on the FFIEC website. I cannot take any positions myself because of a job-based trade restriction.

How fascinating that y’all are talking about banks. I bought some sivb. I don’t normally touch banks as they are mostly garbage. But due to the super low prices I bought around 220.

Looks like a solid play. Definitely attractive P/E and efficiency ratios. One thing to watch if you’re long-term will be how they manage drum roll liquidity.

Looks like they’ve borrowed to offset about $13 million of deposit runoff, which is interesting because they have $11.7 million chilling in cash (called interest-bearing bank balances) and $95 million in Treasuries. Most banks I’ve looked at are drawing down cash reserves and low-yield investments to fund loan growth, rather than taking the hit to earnings by borrowing.
The rate they’re paying on that 13 mill is 2.17%, compared to the 0.93% earned on cash and 1.30% on Treasuries. Granted, 400k of interest expenses vs. almost 4 million of interest revenue is pretty stout compared to pre-covid.

My, how the turns table! The Fed rate hikes claim their first victim. Bloomberg - Are you a robot?

I know that feel.