The "loss" is approaching $700 billion! U.S. bond rates soaring, the U.S. banking crisis is coming again?
When the "anchor of asset prices" soared to a record, the pressure on U.S. banks for interest rates increased sharply.
Recently, a number of major Wall Street banks, including Goldman Sachs and JPMorgan Chase, warned of the risk of high interest rates, and Deutsche Bank strategist Steven Zeng also pointed out in the report that if interest rates continue to rise, the banking crisis is likely to be repeated.
Zeng said the surge in interest rates in recent months has undoubtedly widened unrealized losses in bank bond portfolios, which also catapulted regional bank failures earlier this year.
Using data from the Federal Deposit Insurance Corporation (FDIC), Deutsche Bank estimates that unrealized losses in the U.S. banking sector are likely to exceed $700 billion in the third quarter of this year, up from a peak of $689.9 billion in the third quarter of 2022:
The 10-year yield rose more than 70 basis points in the quarter. In addition, in the second quarter, the U.S. banking sector held $5.436 trillion in debt securities, mainly agency mortgages and Treasuries.
If you just assume that the 10-year Treasury has a key rate duration of 3.5, all else being equal, these securities would lose $140 billion in value this quarter.
Zeng concluded that while systemic solvency risks in the U.S. banking sector are low, lower valuations of securities could put pressure on banks' capital adequacy ratios, potentially reducing banks' willingness to lend and reducing credit flows in the economy.
Of course, through this mechanism, rising yields will also continue to push inflation and economic growth towards the Fed's goals.
As Wall Street News has mentioned before, financial conditions are tighter today than they were then. The banking sector now has the Fed's BTFP policy tool at the bottom, so there is no risk for the time being, but in six months, the BTFP mechanism will expire. The negative impact of high interest rates on financial markets may be further transmitted in the future.
Goldman Sachs trader Sarah Cha referred to the banking crisis earlier this year in her latest daily briefing:
Yesterday we saw a "perfect storm" and another morning to wake up with long-term yields higher, credit spreads widening, and stocks falling. I think the takeaway from many is that when these three things (= risk aversion) become true, there is not much "safety" in financial stocks.
As a result, Goldman's trading arm has refocused a lot of its attention on banks, but not for good reason.
Does the market think we will have another March 2023, or something else? While much of the recent discussion has revolved around portfolio losses in securities (HTM + AFS) and adjusted capital ratios, we believe that most of the well-founded discussions so far have been not about existential risk, but rather about ongoing liquidity pressures and depletion of profitability, with banks focusing more on optimizing balance sheets if deposit pricing (i.e. interest rates) continues to move higher.
Goldman Sachs noted that banks have been sacrificing gains and losses to improve capital outcomes as capital pressures have begun to mount, and since the third quarter of '22, the big four U.S. banks have purchased large amounts of credit default swaps (CDS) every quarter to meet better regulatory capital handling standards, the number of CDS purchased has increased by 47% year-over-year, and securities balances have also declined during this period.
As the market tries to test this segment of banks against the backdrop of higher interest rates, with their adjusted spot capital below ~7%, those banks that may declare victory early or advance RWA (risk-weighted asset) optimization and cost reduction are some of the first banks that the market seems to be focusing on the downside.
Moreover, although the stock market has not reacted, default swaps by major US banks have expanded dramatically.