Many depositors were shocked by the SVB collapse, which, in our opinion, demonstrates that the majority of them are ignorant of serious systemic risks in the U.S. banking system.
In fact, we specifically warned about this issue residing at the major banks in an article just weeks before SVB (SIVB) collapsed:
"Maturity mismatch is also being ignored
This is another major issue that is not being tested by the Fed. Many U.S. banks have a large maturity mismatch between their assets and liabilities. For example, in our recent article on Capital One (COF), we showed that 84% of the bank's securities have maturities longer than 10 years. Capital One does not disclose the average maturity of its deposit book, which is a major part of its liabilities; however, it's highly likely that it's much less than 10 years, especially given that Capital One currently does not offer deposits with a term of more than five years. Such a maturity mismatch between the bank's assets and liabilities would likely lead to major liquidity issues in a volatile environment and be a significant risk for depositors."
In fact, as one of my 1,000 money manager clients noted to me yesterday:
"Funny. A colleague said "no one saw this issue with the banks"... I just laughed and told him Avi from EWT was all over it."
As we already repeatedly warned about maturity mismatch-related risks in our previous articles, which were the cause of the SVB failure, we will not discuss the SVB case in this one. Instead, we'd like to talk about the risks that have not yet materialized but still pose serious threats to the American banking system, especially to large banks, which are currently regarded as a safe haven and are attracting deposits.
And, if you would like to read the public articles we have written on the larger banks, and the issues therein, feel free to read them here:
The Credit Suisse Drama
The failures of SVB and Signature Bank (SBNYP) largely overshadowed the problems with Credit Suisse (CS). But, in our view, this case is very significant and highlights the issues that could seriously endanger the large U.S. banks. The CS story had been developing quite rapidly. On March 14, the bank published its 2022 annual report, in which it mentioned that it had identified a material weakness in its reporting procedures that could result in misstatement risks. Here is a quote from the bank's 2022 annual report:
"Credit Suisse Group's management has made an evaluation and assessment of the internal control over financial reporting as of December 31, 2022. Based upon its review and evaluation, the Group's management has concluded that, as of December 31, 2022, the Group's internal control over financial reporting was not effective as it did not design and maintain an effective risk assessment process to identify and analyze the risk of mate- rial misstatements in its financial statements. As Credit Suisse (Schweiz) AG relies on the Group's internal control framework designed for the preparation of the financial statements, the Board of Directors of Credit Suisse (Schweiz) AG concluded that this material weakness could result in misstatements of account balances or disclosures that would result in a material misstatement to the annual financial statements of Credit Suisse (Schweiz) AG that potentially would not be prevented or detected. As a consequence, the statutory auditor PricewaterhouseCoopers AG (PWC) has noted that Credit Suisse (Schweiz) AG did not design and maintain an effective risk assessment process to identify and analyze the risk of material misstatements in its financial statements within this system."
The next day, the chairman of the Saudi National Bank, which was a top shareholder of CS before the deal with UBS (UBS), ruled out any additional increases in its stake in the bank. That has triggered another decline in the bank's share price, and, as the media said, the U.S. Treasury Department had started reviewing the U.S. financial sector's exposure to CS.
On Friday, the media reported that at least four large banks had restricted trades with CS. There also was news from Bloomberg that BNP Paribas, a French bank, will no longer accept requests to take over their derivatives contracts when CS is the counterparty. The acquisition of CS by UBS has stabilized the situation for now, but the risks remain.
The fact that U.S. banks have tens of trillions of dollars in derivatives on both their balance and off-balance sheet has been repeatedly mentioned in our previous articles on large banks. In the event of a systemic crisis, this could cause serious problems for the banks and ultimately for depositors. Here is a quote from our article on Credit Suisse.
"The table shows that CS's notional amount of derivatives is CHF15T, which is almost 70% of the total U.S. GDP. Yes, this is notional amount, and after netting it becomes much smaller. However, majority of these derivatives are OTC contracts, which are the riskiest type of derivatives, especially in a recessionary environment when there is a high chance of a counterparty default risk. It is highly likely that CS is among derivative counterparties of large U.S. banks, and in a crisis scenario CS likely would not be able to meet its obligations under these OTC contracts. This would lead to major losses for U.S. banks, and eventually for their retail depositors."
This significant risk was once again brought to light by the news that several sizable banks restricted trading with CS and that at least one stopped working with those derivatives where CS is a counterparty. Naturally, the largest American banks are those that are most at risk from this issue.
Rising Delinquencies In Unsecured Lending
The sector's non-mortgage retail lending is another problem that was largely overshadowed by the SVB collapse. Over the past few quarters, this segment has seen an increase in charge-offs and delinquencies, and we think this is just the beginning of the story. Recently, credit cards and car loans have appeared to be particularly weak, as we covered in our article on Capital One. A further deterioration in the segment could result in significant losses and even render some large U.S. banks insolvent, given that they have significantly increased their exposure to unsecured retail lending.
The Quality Of Corporate Credit Portfolios Also Raises Questions
Another major issue is the poor quality of corporate loans granted by the large banks. Here's an excerpt from our article on Goldman Sachs (GS), for illustration:
"GS's corporate book is extremely risky as 70% of loans were granted to non-investment-grade borrowers. The history tells us that there is a high probability that these borrowers would default in a recession environment. It is also worth mentioning that 33% of corporate loans were granted to EMEA's clients, which would likely hit the hardest in a global crisis."
Just as a reminder, a non-investment-grade borrower is what the media now calls a junk borrower.
Is The LCR A Reliable Metric In A Crisis Environment?
During these debates around SVB and Signature Bank, several experts and analysts mentioned that the liquidity position of large banks is more transparent as they regularly submit their LCRs (Liquidity Coverage Ratios) to the Fed. According to the regulator, the LCR rule requires large banks to calculate and maintain an amount of high-quality liquid assets sufficient to cover their total net cash outflows over a 30-day stress period. The LCR ratio is calculated as a bank's high-quality liquid assets divided by its total net cash outflows.
We note that the LCR is essentially useless in a financial crisis situation, despite the fact that we do agree that it's a useful metric in a situation of stable economic conditions. First, the rule states that a bank's high-quality liquid assets not only cash and Treasury securities, but corporate bonds and equity securities as well. Of course, in a crisis situation, the value of corporate bonds and equities could decrease significantly. Second, until a true crisis occurs, no one will know if the LCR rule gives banks enough liquidity to handle outflows.
The Bottom Line
If the media currently discusses only a maturity mismatch risk and unrealized losses on AFS and HTM securities, it does not mean that the U.S. banking system does not have other risks, some of which we have mentioned in this article (as well as the many articles we have written over the past year warning about these issues in the banks). We believe retail depositors should be well aware of those risks, as their materialization would have a much more significant implication for the banking system compared to the SVB collapse.
In contrast to the large U.S. banks, the Top-15 U.S. banks we have found at SaferBankingResearch.com have been stress-tested for various issues and have proven their resilience even under severe financial conditions. Our methodology is here.
At the end of the day, we are speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money. You have a responsibility to yourself and your family to make sure you money resides in only the safest of institutions. And, if you are relying on the FDIC, I suggest you read our prior articles which outline why such reliance will not be as prudent as you may believe in the coming years.
This article, as well as Saferbankingresearch.com, was a combination of efforts between Avi Gilburt and Renaissance Research, which has been covering U.S., European, LatAm, and CEEMEA banking stocks for more than 15 years.
For those interested, Saferbankingresearch.com covers banks in the US, and has recently begun expansion into European banks, and will continue its expansion later this year into Canadian banks.