Bank Bonds Tumble Into Distress

having me. We're also very pleased to welcome Arnold Kakuda, who covers banks for Bloomberg Intelligence in New York, and Yuron Julius, who has the same responsibilities but it is based in London. Hi, James Loo, great to be here. Banking is the hot topic at the moment. We'll be getting to their insight in a little bit, but before we do, Amelia Pollard with Bloomberg News, it's been a roller coaster ride for banks. What's going on? We've had a bit of a regional banking crisis in the US.

Can you walk us through what happened though? Yeah, it's been a crazy week. It started last week with silver Gate Capital, which is known as you know, the big bank to crypto. It counted FTX among its biggest clients. And so there were mounting concerns about silver Gate early last week, and then on the Wednesday announced that it

was going to do a voluntary wind down. So it didn't technically count as a bank failure by the FDIC's definition of when a bank has to fall into FDIC receivership and the federal agency effectively takes over the bank, but by you know, it failed in the sense that it you know, ceasing operations. And then just the next day, on last Thursday, trouble started for a Silicon Valley bank, which was another of these banks that had become highly

specialized in one sector. It started in nineteen eighty three and ever since then really has been the bank for venture capitalists and the tech sector specifically startups were their main clients, and rumors started to fly in the tech world that the bank wasn't as sound as it had previously indicated, and that was in part because it was stuck in these long dated treasury bonds and was trying to unwind from them and raising fresh capital as a result, and so a real true bank run ensued and all

of these tech startups and venture capital funds started to pull their money. It was later reported that a total of forty two billion dollars was attempted to be pulled from the bank last Thursday, and the next day around you know, eleven thirty am New York time, it fell into FDIC receivership and was ultimately the second biggest bank failure ever and the biggest one since Washington Mutual in

two thousand and eight. So that rocked markets. A bunch of other regional banks, including First Republic, then started their chairs plummeted, their trades were halted a few times last Friday, and then a few days later. The saga continued on Sunday when Signature Bank fell into FDIC receivership. Signature Bank is based in New York, so it was no longer

a California story. Silver Gate Capital and Silicon Valley Bank were both based in California, and you know, it was the second bank to fall into failure within a week in FDIC receivership. So we've been all reeling from that here on the market team, and you know, the distress team has been trying to track how far the fallout

will reach in terms of regional banks. But the federal government denounced they were going to backstop not only the insured limit of the two hundred three thousand dollars deposits, but you know, make all depositors whole. So nine over ninety percent of the Silicon Valley bank depositors were over that two hundred thousand dollars threshold. So that I think really kind of short up confidence for the time being

in the banking sector. But there's been some volatility this week even still, we haven't seen banks like this failed since the financial crisis the two thousand and eight. Is this a Lehman moment? You know, earlier this week we said it wasn't the Lehman moment, but then you know, Credit Swiss stap and some you know, distress trading started yesterday for some other credit swee sponse. By all metrics, it doesn't seem to be a Lehman moment, you know.

I think that the fact that the FED stepped in so quickly in backstopping those deposits has for now calmed out, calmed down investors and you know, just those with bank accounts everywhere and not pulling their funds. I think it is people are still bracing though, to see how this

shakes out in the coming weeks. But it seems some there's been some comparison from a few investors to Bear you know, this might be a Bear Stearns moment, which actually failed exactly this week in two thousand and eight, So there's some odd parallels there with timing. So you mentioned Credit Swiss, that's a much bigger issue potentially a huge Swiss bank with sprawling global businesses that bonds fell

into distress, they keep getting more distressed credit defaults. Who helps and play a high high chance of default even after the Swiss National Bank through them a lifeline. What's the story there? You know, it's a tenuous connection between what's happening in the US regional banks and what's happening

with Credit Sweets. But I think it's a sentiment of their being kind of concern globally among investors and especially you know, after the regional banks started to tumble last week in the US, we were starting to see, you know, shares among European banks even we're starting to fall, and I think that was a kind of a harbinger for

what was to come this week with Credit Sweets. I think the fact that bonds are still trading in the distress level today and are falling again even after the Swiss National Bank backstopped the bank and said that they would provide fresh liquidity. Is a sign that the story is not over here, but it is too soon to tell exactly how Credit sweece will play out on coming days. Very interesting, Ameliapole of Bloomberg News, thanks so much for

joining us. This is a fascinating story with broad implications, and we look forward to reading all of your scoops on the Bloomberg terminal and of course at Bloomberg dot com. Thanks so much, James. Switching gears here a bit. As I mentioned earlier, we're very fortunate to have Arnold Kakuda and Uron Julius from Bloomberg Intelligence who really know this sector. Well. We're looking forward to hearing your take. I'll start with Yuron, since Europe is really the kind of epicenter here, that's

where Credit Swiss is based. What's the situation right now? How is the crisis playing out? Well? Thank you, James. That is that is a big question that we're all trying to get to get an answer to. It is still it is too soon, i think too to be definitive about how is this going to play out? The Swiss Central Bank has come in and provided Credit Swiss with access to a liquidity facility, to two liquidity facilities in fact, will buy credit Suite some time. Will it

be enough? We don't know. The amount mentioned is fifty billion in total. You know, the look that number may have been plucked out of thin air. It looks you know, it's a serious enough number. Is it large enough? Had they decided on a few hundred billion, uh, you know, that would have been perhaps too large. And also you know this is a collateralized facility, so credit suites that needs to have the the the assets to pledge against this this liquidity that it will take from the Swiss

National Bank. But but look, you know, the early response to this, to this provision of emergen liquidity has been positive. But it does seem to be fizzling out a little bit. And if we take a step back, you know, what is that issue here? The immediate crisis It was triggered, triggered by Silicon Valley Bank, the reader cross. I totally

agree with Amelia. It's the the read across asilit Valley Bank for a credit suis isn't all that immediate because if you look at the unsecured lasses, sorry, unrealized lasses or bond portfolios. That wasn't really the issue for cred Swiss. The large majority of its securities are in its trading book. You know, these are marked to market, so that's not really the issue. I think what happened is that you know, Silicon Valley Bank, you know, unfolded and people started to

worry about liquidity issues elsewhere. Forget about nuance. It was just you know where which banks have liquidity issues. And if you look at Credit Suis in the fourth quarter, it did see a massive outflow of client assets, you know, reflecting concern over its over its earnings, over its franchise. And at the same time the bank has announced this huge restructuring, So you know, I think it's important to realize that that there are some parallels, but it isn't.

It isn't the same story as what played out in for Silicon Valley Bank. But look to hard to be as I mentioned, how to be definitive, how this is going to this is going to play out. Ultimately, what you need to see is sentiments starting to stabilize, spreads starting to stabilize um and we're not seeing that yet. It's a huge institution, has counterparties across the board in all sorts of markets, and you know structured finance and investment banking and just about you know, every asset class

you can think of. What impact is it having across Europe at this point, Well, all European banks are done clear clearly, everyone's very jittery and wondering, you know what what's going on? What is the read across for for for the entire sector. But U I think sentiments should sort of stabilize. If you look at the risk to

liquidity and then specifically the risk of deposited outflowers. The vast majority of European bank deposits they are in shirt, right, so sixty three of deposits are in short according to EBA data. If you look at the deposit mix, the last majority of European banks deposits are retail, so stickier arguably, and those two metrics they contrast with what you saw that Silicon Valley bank. So I think that's that's important.

I think overall it's also important to realize that European banks are very much regulated, very very tightly, at least the large ones, particularly a bank like credit suites believe it or not. As a global stemically important bank, it has had much more regulatory oversight and intrusion than perhaps some of the small to medium sized banks in the

over in the US. But that's you know, that's not to to to play to be diminished the challenge because if you look at what happened to the deposit base in the fourth quarter, it did actually drop, It did actually come down by four percent, and more may follow. And that reflects two things. It reflects the cost of living crisis. Some depositors, you know a lot of clients they are using their savings to to help them through

this difficult period. It also reflects depositors taking their money out of their savings accounts and taking them into money market funds, so higher yielding alternatives and those two drives they remain in players. And I do think that you may see some further deposit outflows in the coming in the coming months and quarters. But it's all it's all coming from from a healthy base. Don't remember, they don't forget that. You know, banks deposit they shot through the

roof during the pandemic and that's coming off now. So yeah, the high rates hadn't been good for banks. Um, well, the concerns of you was that that higher rates were supposed to be good for banks, and in some ways they are. You know, they do allow banks to earn a greater higher marginal their lending. And you know, that was the thinking that interesting incomes should should benefit and if you look at the recent results, that's exactly what happened.

That interesting most European banks has gone up, in some cases massively. But there's also realization that higher rates come with lower marks on your on your boob porfilio and you know that, you know that there's one aspect. And now with those deposit outflows, the realization has now hits that banks will have to pay up for those deposits to hang onto those deposits, so that will eat into margins and that will sort of be a bit of an offset. But overall, net net, I still think that

higher rates are positive for European banks banks in general. Okay, great, you're in, Thank you so much. And Arnold from your that's Devnaldcuda bug Intelligence in New York. What's the moods over in the US right now? How scared should we be about the bank? So will others fail? Yeah? I mean the mood is very yeah, like uncertain and scary. Um you know, Silicon Valley bank signature, these are both IG names and then um, you know, in hispan of one to two days, they went from IG to um

bus right, so uh, definitely concerns. And then um, you know it was seen as kind of the bigger banks, like the JP Morgan's via bas kind of they could benefit more from potential deposit outfloor or inflow from some of these regionals. But then we get like a credit swist where okay, you know, something were to happen there you know, definitely a lot of counterparty risks. So definitely a lot of concern in the bank financial space given you know, contagion or you know, who's next kind of thing.

So um physicum metrics that we look at, at least on the spread side are financials versus the overall bond index, and um, you know kind of before this uh turmoil, um banks, Uh, financials, let's let let's use the financial sector as a proxy, had almost traded flat to the corporate bond index. But then given how you know, the Silicon Valley bank failure as well as you know, credit Swiss volatility, has happened, you know, just within a span

of a week. You know, now now the financial sector is about twenty five wider than the overall UH corporate bond sector. So definitely a lot of jitters going on right now. Just um you mentioned earlier IG just for listeners who may not be where that means investment grade, which um, the bonds of credit Swiss still actually are, even though the trading like distressed junk today. UM. So that's that's an interesting feature of the market. But but

you mentioned, you know that maybe others in trouble. I mean, is there going to be widespread contagion? What are the weakest links here? I mean, you know, even now there's concerns with a First Republic h bank, which is uh they only have about eight hundred million of of of UM subordinated debt, which are which are well they were IG until two days ago UH and there togo UM before the rating agencies pick it down to UM high

yield UM. But yeah, it's these models where they're you know, as eurone had talked about a lot of uninsured deposits right a high high level of balances, so um, it could be that you know, when there's a lot of uncertainty with Silicon Valley Bank unless say the Friday and there was a concern where uninsured depositors would not be made whole. That's when you know people got concerned and

they might have already moved their money. And so you know what what the FED and the FDAC the regulators have done is to implement some measures to kind of help. But you know, if if the bank run, if deposits run out so fast that they overwhelm kind of the the liquid security PO portfolios at these banks do you have and which have gained a lot of unrealized losses, right, it might overwhelm that. So you know, it might be too late. And that's I think that situation happened at SBB.

So um yeah, and it's ironic that all this stuff is ahead of a potential recession. And you know that's where we kind of delve into, um, you know what's gonna happen to the loan portfolios as the economy gets hours, Consumers are impacted, business are impacted, and then that's when

you start seeing loan losses. But you know where the model, you know, the market is currently concerned with, um, these models where they have a lot of unsecured deposits, and then they invested in bond a big bond portfolio, sovereign bond portfolio or agency mbs triple A rated securities that have accumulated losses and um and and the accounting for these regional banks is, you know, those unrealized losses, they

didn't hit capital levels. So it's a confluence of you know, deposits not being sticky where they thought they were liquid acid it's not really being liquid because you know, banks didn't want to sell it for losses. And then lacks accounting rules for these kind of mids of small sized regional banks where they didn't have to account for those unrelifed losses in their capital levels. I think we should really time stamp this conversation because things are moving so quickly.

This is much sixteen eleven fifty in the morning in New York. Anything could happen. But I would like to ask both of you, your Ron first, and then Arnold, same question I asked Amelia earlier. Is this a Lehman moment for for banks and for the economy. Let's start with your un what's your view? No, I don't think so. I think you know banks globally and European banks you know, of course, those are the ones that I that I

look at the daily basis. The overside, the regulation, regulatory framework has been tightened so much since then, um, since since the two thousand and eight and before, so it's it's you are looking at a completely different UH sector. UM. Now, undoubtedly there are many challenges ahead of us, but UM, I'm confident that ultimately, you know, the strength the resilience of the of the regulatory framework should prevent a Leman

type scenario playing out. I mean, I agree, it's a it's a no for me on Leman, but I would have you at that with I think we need uh more regulation coming into play. But also I think, UM, I think we need more of an explicit maybe deposit guarantee for uninsured deposits, you know, for like a period of a year or two, uh, just given given the

volatility of the market. And and I think the thing that we can point to is during the financial crisis October two thousand and eight, we had that tg T LGP Treasury Liquidity Guarantee program and as a part of that, UM non interest sparing deposits were guaranteed for over a year, right, So when when when when the market psyche is is a little hectic and people just move deposits will um on maybe some um insignificant news, maybe that sort of

thing is necessary, right, And so even though we've gotten these deposits uninsured deposit um were made whole after these you know, signature and SEB when it's a receivership, maybe that's what's needed to kind of explicitly say to everybody you don't need to move your deposits out of regional banks into the bigger banks. So I think a couple of things might be needed just to maybe calm the market sentiment. But yeah, that's that's why I think. Thank you.

I hope you'll write that it's not a Leman moment. This is the biggest story in global finance right now. And you can read all of the analysis of banks by Arnold Kakuta and You're Newlius on the Bloomberg terminal. Thank you so much to you both, and thanks again to Amelia Lord from Bloomberg News. Read all of her scoops on the terminal and at Bloomberg dot com. Really important to keep an eye on that big bank credit

story right now. No matter what part of the market you are in, Amelia and her team will continue to break a lot of news about that in the coming weeks. I'm James Crumby. It's been a pleasure having you. See you next week on the Credit Edge.