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U.S. Banking Crisis 2.0?

U.S. Banking Crisis 2.0?

As the U.S. banking crisis triggered by the collapse of Silicon Valley Bank approaches its one-year anniversary, the alarm is sounding again.

On January 31, local time, the U.S. regional bank, New York Community Bank, reported a thunderous report, with an unexpected loss of $252 million in the fourth quarter of last year, compared with the previous market expectation of a profit of $206 million.

On the same day, the bank's stock price plummeted 46% intraday, hitting a circuit breaker and suspension, and closed down 38%.

The collapse of community banks in New York led to a sharp drop in U.S. regional bank stocks across the board. The Dow Jones Regional Banks Index (KBW) fell 8% in two days, its biggest drop since the regional banking crisis in March 2023.

The New York Community Bank is the successor of Signature Bank, one of the three banks that collapsed in the US banking crisis last year.

Dramatically, just a day before the bloodbath in New York Community Bank shares, the Federal Reserve's Federal Open Market Committee (FOMC) released its latest January statement, in which the phrase "the U.S. banking system is robust and resilient" was removed.

The BTFP program, which saved the banks from fire and water last year, will end on March 11. The Fed's reverse repo facility is rapidly depleting and getting closer and closer to zero. A liquidity crisis for regional banks in the United States is looming.

At the end of last year, JPMorgan Chase & Co.'s chairman and CEO sold his family's stake for the first time and cashed out.

As we approach the first anniversary of a banking crisis that led to the collapse of three major US regional banks and the emergency takeover of Credit Suisse in Europe, a new chill is spreading from the United States to Japan, Switzerland and Germany.

U.S. Banking Crisis 2.0?

Image source: IC

The receiver exploded

The main reason for the collapse was that the bank suffered huge losses from two loans related to commercial real estate, so it set aside more than $500 million for disaster relief, which was ten times higher than analysts' expectations and far more than the $62 million in the previous quarter.

At the same time, in order to raise sufficient liquidity to meet the liquidity requirements of US regulators, the bank was forced to cut its dividend by 70%, from 17 cents per share to 5 cents.

The news of the loss and the cut in dividends instantly frightened investors.

On January 31, New York Community Bank posted a record 38% one-day decline, erasing gains since the acquisition of Signature Bank. On Feb. 1, the pressure continued, with New York Community Bank falling more than 11% to its lowest level since 2000.

The Dow Jones Regional Banks Index (KBW) also fell, falling 8% in two days, its biggest drop since the regional banking crisis in March 2023.

In March 2023, after the collapse of three regional banks in five days, U.S. banking regulators urgently patched up and made the most significant revision to the rules governing bank capital in more than a decade.

In July 2023, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and other financial property flow regulators released the highly anticipated U.S. version of the Basel III "final" rule (U.S. Basel III endgame rules).

According to the draft, the asset threshold for heavily regulated banks would be lowered from $250 billion to $100 billion — and large banking institutions with assets of more than $100 billion would need to raise their capital by about 16% to meet stricter regulatory capital requirements.

The draft also requires all large banking institutions to reflect unrealized gains and losses on available-for-sale securities in regulatory capital.

Under the current U.S. rules governing bank capital, large banking institutions in Category 3 (with total assets greater than $250 billion) and Category 4 (with total assets greater than $100 billion to $250 billion) can choose not to reflect unrealized gains or losses on available-for-sale securities in their regulatory capital. Silicon Valley Bank, which belongs to the fourth category of large banking institutions, has made such a choice.

U.S. Banking Crisis 2.0?

In March 2023, the New York Community Bank took over the "Signature Bank" that exploded, bringing its asset level above the $100 billion mark. This means that the bank will face stricter regulatory requirements, so it will need to set aside more capital and loss provisions.

At present, Moody's has said that it will downgrade all of New York Community Bank's assessments or downgrade the bank's credit rating to junk.

The scourge of commercial real estate

The unexpected financial report of the New York community bank has brought a new round of crisis in the $560 billion real estate loan market to the surface.

According to the American Mortgage Bankers Association, commercial mortgages for hundreds of large U.S. office buildings are due this year, with a total value of $117 billion.

According to Trepp, by the end of 2025, U.S. banks will face approximately $560 billion in commercial real estate maturities, accounting for more than half of total real estate debt maturing over the same period.

Unlike residential loans, U.S. commercial mortgages are almost entirely interest-only but face a large lump sum payment equal to the original loan amount at the mortgage maturity date.

Many commercial mortgages were contracted a decade ago when interest rates were much lower than they are today, and now commercial mortgage rates have nearly doubled.

These property owners may struggle to refinance in the current high interest rate environment, and a large number of commercial properties in the United States are facing difficulties in refinancing or refinancing, which may further trigger a banking crisis.

Some analysts have pointed out that the U.S. commercial real estate industry is experiencing one of the worst recessions since World War II. U.S. economists have found that 40 percent of office loans on bank balance sheets are in negative equity, which could create problems for dozens of regional banks that hold these loans.

In fact, due to rising interest rates, economic uncertainty, and the popularity of remote work, overdue commercial real estate loans from U.S. banks have reached their highest level in a decade.

The International Monetary Fund (IMF) has warned that the U.S. commercial real estate market is at serious risk and is currently in its worst phase of decline in the past half century. Since the Federal Reserve began raising interest rates in March 2022, U.S. commercial real estate prices have fallen by more than 11%, completely erasing the gains of the past two years. The decline far outweighed the impact of previous rate hike cycles.

The IMF stressed that financial regulators must remain on high alert. As delinquencies and defaults rise, lending can be restricted, triggering a vicious cycle: tighter financing conditions, further declines in commercial property prices, and losses to financial intermediaries, ultimately with negative spillovers to the rest of the economy.

"Compared to the imminent defaults in 2024 and 2025, the percentage of loans delinquent reported by banks so far is just a drop in the ocean. Banks remain at significant risk, and the imminent fall in interest rates will not solve the bank's problems. David Aviram, head of Maverick Real Estate Partners, a private fund specializing in commercial real estate lending, issued a warning.

The deterioration of the U.S. housing market has spread to Asia and Europe.

On February 1, Seokora Bank in Tokyo, Japan, disclosed that due to losses related to commercial real estate in the United States, the company expects a net loss of 28 billion yen (about 1.359 billion yuan) for the fiscal year ending March this year, recording a quarterly loss for the first time in 15 years, after expecting a profit of 24 billion yen. The bank's president and CEO will resign on April 1.

Affected by this news, the share price of Qingkong Bank fell 21.49% on the day. Prior to the announcement, the bank's share price had been near a five-year high.

It is reported that Qingkong Bank holds a balance of $1.9 billion in office loans in the United States, accounting for 6.6% of the total loans. Blue Sky Bank warned that it will take two years for the U.S. office market to stabilize.

On the same day, in Europe, Deutsche Bank, Germany's largest bank, disclosed that its loss provisions for U.S. commercial real estate in the fourth quarter of 2023 increased more than fourfold year-on-year. The bank made a provision of €123 million for its underlying portfolio, well above the €26 million recorded in the same period in 2022 and almost double the amount of the bank's provision in the third quarter of 2023.

Concerns surrounding real estate are not limited to the United States.

Also on February 1, Julius Baer Group announced that the company had made a loss provision of nearly $700 million due to a loan to Signa Group, a private Austrian real estate company, and its profit fell by more than 50%. The losses were heavy enough to cause the departure of its CEO.

At last month's Davos forum, Anne Walsh, chief investment officer at investment bank Guggenheim, pointed out that the pain in the office sector of commercial real estate is just beginning. "Small and medium-sized banks will face a large refinancing of office loans over the next 24 months. This situation can be seen as a rolling recession in the banking sector, which is likely to continue for some time."

The BTFP expires and is not renewed

BTFP, the "Bank Term Financing Program," is a new bailout tool that the Federal Reserve urgently pulled out during the regional banking crisis triggered by the Silicon Valley Bank explosion in 2023. At that time, BTFP was interpreted by Wall Street as a disguised form of quantitative easing (QE).

To put it simply, the Fed acts as a "lender of last resort", allowing commercial banks to pledge U.S. Treasuries and agency bonds at face value and borrow funds with a maturity of no more than one year, so as to ensure that the banking sector has sufficient liquidity to cope with the run.

When banks are in a run, they usually sell their most liquid assets, such as Treasuries, to raise cash and pay depositors. The market price of Treasury bonds is inversely proportional to the level of interest rates in the market, in other words, when the level of interest rates in the market rises, the trading price of Treasury bonds falls.

As a result, after the Fed started to raise interest rates in March 2022, the value of Treasury assets in the hands of the banking sector has been shrinking and there has been a paper loss. When SVB faced a run, it had to sell Treasury bonds at a loss to recoup cash, causing a paper loss to become a real loss.

The BTFP mechanism, introduced by the Federal Reserve, denominates the securities pledged by the borrower at face value rather than market value, and then implements the loan operation.

Under the BTFP mechanism, banks can obtain a $100 loan from the Federal Reserve Bank with a bond with a market value of $80 as collateral. In the discount window operation, an $80 bond can only be exchanged for an $80 loan. 

Unsurprisingly, this mechanism has succeeded in propping up the balance sheet of the entire banking system, preventing a run that could have turned into a serious crisis.

However, things are starting to go against the Fed's intentions. BTFP has mutated into a machine for banks to lie down and make money.

Since its launch in March last year, the tool's usage has climbed rapidly to around $100 billion in the first few months before leveling off at that level.

However, as the aftermath of the banking crisis fades, the use of BTFP has increased instead of declining – since November 2023, the use of BTFP has risen sharply. In the week ended January 17, the balance of the instrument reached a record $161.5 billion.

Prior to the introduction of the BTFP, the Fed had been using the discount window as a long-term option to meet banks' liquidity needs. In the week ended Jan. 17, banks used just $2.3 billion in the discount window, well below the all-time high of $153 billion set in March last year.

Behind the surge in BTFP usage is not a resurgence of liquidity crunches in the banking system, but rather the market seeing significant arbitrage space between BTFP and the federal funds rate.

The initial BTFP rate is a one-year interest rate set by the financial markets, plus a 10 basis point premium. The one-year interest rate set in the financial markets is based on forecasts of the Fed's policy rate in the coming year. As investors expect the Fed to cut interest rates aggressively, borrowing costs are currently at just 4.8%, meaning that the market is betting that the policy rate will be around 4.8% in a year's time, which is lower than the Fed's current benchmark rate of 5.5%.

And so the magic happened – the interest rate on deposits at the Federal Reserve was higher than the rate on its loans.

Financial institutions can borrow from the Fed at a low interest rate through BTFP and then lend at a higher interest rate in the federal funds rate market, enabling risk-free arbitrage.

On January 12, JPMorgan Chase reported a record "net interest income" for the seventh consecutive quarter.

On January 24, local time, the Federal Reserve announced that from now on, it will raise the BTFP interest rate, and the increased BTFP interest rate will be "not lower" than the interest rate on the reserve balance in effect on the day of loan disbursement. This means that the arbitrage space is completely gone.

The Fed also announced that the temporary tool will end on March 11 as originally planned, with no further lending stopped. Banks and other depository institutions will be able to take advantage of the discount window to meet liquidity needs.

The non-renewal of the BTFP expiration, the start of an "occasional" jump in the repo rate, and the fact that the overnight reverse repo (ON RRP) is being depleted all suggest that liquidity risks may erupt in the next concentration.

When the Fed will act

It's not just the regional banking crisis that hangs high, but the big US banks are also in dire straits. The interest rate differential income from the Fed's real money has not been able to stop the performance of the big Wall Street banks from falling.

According to the recently released financial report data for the fourth quarter of last year, the net profit of the four major U.S. banks, such as JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup, has declined to varying degrees quarter-on-quarter and year-on-year.

JPMorgan Chase achieved a net profit of US$9.307 billion in the quarter, down 29% and 15% quarter-on-quarter and year-on-year, respectively, Bank of America achieved a net profit of US$3.144 billion, down 59.7% quarter-on-quarter and 55.92% year-on-year, respectively, Citigroup reported a net loss of US$1.839 billion in the quarter, turning a profit into a loss from the previous quarter, and Wells Fargo achieved a net profit of US$3.446 billion in the quarter, down 40% from the previous quarter.

Not only did the financial reports of these banks fall short of analysts' expectations, but they also reflect that the profitability of the industry as a whole is taking a major hit.

The increase in the pressure of bad debt provision and the decrease in interest income have become the direct reasons for the decline in the bank's performance. Due to the increase in borrower defaults, banks have had to increase their bad debt provisions to cover possible losses, which directly affects banks' net profits.

At the same time, Wall Street banks are still paying for last year's regional banking crisis in the United States.

The FDIC spent about $23 billion to clean up the mess they left behind. The FDIC requires large banks with total assets of more than $50 billion to bear 95% of the total losses of the deposit insurance fund. JPMorgan Chase paid $2.9 billion for this, Bank of America $2.1 billion, Citigroup $1.7 billion, and Wells Fargo $1.9 billion.

Last year, the U.S. banking sector was the hardest hit by layoffs. In the context of stagnant income, the U.S. banking industry, led by Wells Fargo and Goldman Sachs, has set off a wave of layoffs in order to reduce costs.

Recently, Citigroup announced that it would lay off about 20,000 employees by the end of 2026 on the day of its worst quarterly performance in more than a decade, which will reduce the total number of Citi employees by about 10%.

In the early morning of February 1, Beijing time, at the first interest rate meeting in 2024, the Federal Reserve once again stood still. Fed Chair Jerome Powell has clearly dealt a blow to hopes of a rate cut as early as March.

This is not good news for the banking industry.

First and foremost is commercial real estate, the current source of pain for regional banks. Since the cycle of commercial real estate loans tends to be between 5 and 10 years, most of the loans that are about to mature are issued during periods of high housing prices and low interest rates. The longer the Fed insists on not cutting interest rates, the more homeowners will fall because they can't afford to "borrow new to pay for old".

A more systemic effect is that interest rates are running high, causing the U.S. banking sector to "come in less and get more out."

In terms of "accounting", the value of assets such as bonds held by U.S. banks has shrunk significantly due to interest rate hikes. At the same time, interest rate hikes have also led to the loss of deposits from many banks.

In terms of "billing", interest rate hikes have increased the operating costs of US banks. Banks must now pay more interest on deposits to retain and attract depositors.

After the news of the New York Community Bank's earnings report, the more policy-sensitive two-year Treasury yields plunged by 15 basis points, and the 10-year Treasury yield also plunged by 10 basis points.

On 1 February, US bank stocks fell for the second day in a row, raising fears of a resurgence of the banking crisis, with traders expecting the Fed to accelerate the pace of rate cuts. Swap contracts show a slight increase in the likelihood of a rate cut in March.

And that's just a day after Powell poured cold water on interest rate cut expectations.

The logic behind this is that once there is a crisis in important sectors such as regional banks and US commercial real estate, the Fed will have to enter a state of bailout.

Some analysts pointed out that if the Fed does not take steps to reduce quantitative tightening or cut interest rates at the March FOMC meeting, there may be a large-scale sell-off in the bond market, which in turn will exacerbate the loss of held-to-maturity securities on bank balance sheets. This will cause depositors to turn to money market funds for higher interest rates, putting banks under pressure to repay depositors' funds. In this case, without the support of the BTFP mechanism, the bank can only rely on the discount window to obtain loans at market value, which will decrease as the price of the bond falls, which may eventually lead to the bank's bankruptcy due to the inability to cover the unrealized losses.

Reporter Bai Yanbing

Edited by Cheng Hui

Editor-in-charge: Sun Xiao

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#959595}}@media(prefers-color-scheme:dark){.wx-root:not([data-weui-theme=light]),body:not([data-weui-theme=light]){--weui-BG-0: #111;--weui-BG-1: #1e1e1e;--weui-BG-2: #191919;--weui-BG-3: #202020;--weui-BG-4: #404040;--weui-BG-5: #2c2c2c;--weui-FG-0: rgba(255, 255, 255, .8);--weui-FG-HALF: rgba(255, 255, 255, .. 6);--weui-FG-1: rgba(255, 255, 255, .5);--weui-FG-2: rgba(255, 255, 255, .3);--weui-FG-3: rgba(255, 255, 255, .1);--weui-FG-4: rgba(255, 255, 255, .15);--weui-FG-5: rgba(255, 255, 255, .1);--weui-RED: #fa5151;--weui-ORANGERED: #ff6146;--weui-ORANGE: #c87d2f;--weui-YELLOW: #cc9c00;--weui-GREEN: #74a800;--weui-LIGHTGREEN: #3eb575;--weui-FIRE: #07c160;--weui-BLUE: #10aeff;--weui-INDIGO: #1196ff;--weui-PURPLE: #8183ff;--weui-WHITE: rgba(255, 255, 255, .. 8);--weui-LINK: #7d90a9;--weui-TEXTGREEN: #259c5c;--weui-FG: #fff;--weui-BG: #000;--weui-TAG-TEXT-RED: rgba(250, 81, 81, .6);--weui-TAG-BACKGROUND-RED: rgba(250, 81, 81, .1);--weui-TAG-TEXT-ORANGE: rgba(250, 157, 59, .6);--weui-TAG-BACKGROUND-ORANGE: rgba(250, 157, 59, .1);--weui-TAG-TEXT-GREEN: rgba(6, 174, 86, .6);--weui-TAG-BACKGROUND-GREEN: rgba(6, 174, 86, .1);--weui-TAG-TEXT-BLUE: rgba(16, 174, 255, .6);--weui-TAG-BACKGROUND-BLUE: rgba(16, 174, 255, .1);--weui-TAG-TEXT-BLACK: rgba(255, 255, 255, .5);--weui-TAG-BACKGROUND-BLACK: rgba(255, 255, 255, .05)}}@media(prefers-color-scheme:dark){.wx-root:not([data-weui-theme=light]),body:not([data-weui-theme=light]){--appmsgExtra-BG: #121212}}

div.autoTypeSetting24psection > p,div.autoTypeSetting24psection > section{margin-bottom: 24px;}

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