The Banking System - The Heat Is On

... The shadows high on the darker side
Behind the doors it's a wilder ride
You can make a break, you can win or lose
That's a chance you take when the heat's on you
When the heat is on...

- Glenn Frey, The Heat is On

Make no mistake about it. Our banking system is in crisis mode. The effects of this will be wide-ranging, including real estate loans, corporate loans, personal loans, mortgages, credit card interest rates, the U.S. Prime Rate, and every other type of lending that you can consider. Bad management is certainly one of the factors driving this, but it is also, in my opinion, poor decision making by the Fed which has added to this fire. The Fed kept interest rates too low for too long, and then, in their fight against inflation, they have raised rates far too quickly. The truth of the matter, between these two mistakes, is that banks are just getting clobbered.

In my humble opinion, the Fed just needs to stop and let things cool down.

Regulators have now shut down Silicon Valley Bank (SIVB), Silvergate Bank (SI) and Signature Bank (SBNY). Moreover, during the past week, the KBW NASDAQ Index has dropped -15.0% and the KBW Regional Bank Index is down -11.0%. Some of the specific regional bank stocks have fared far worse. First Republic Bank (FRC), for the week, was down 71.8%, Western Alliance Bank (WAL) dropped 36.5%, KeyBank (KEY) fell 26.4%, Comerica (CMA) was down 25.9% and Zions (ZION) dropped 25.8%.

It was not just the equities that got hammered either. First Republic Bank was cut to junk by Moody’s on Friday. Moody’s cut First Republic’s debt to B2 from BAA1. Last Wednesday, S&P cut their debt rating to BB+ from A-, and Fitch cut their rating to BB from A- on the same day.

What is even more concerning is what is happening at the Fed. Last week, American banks tapped the Federal Reserve’s emergency facilities for a record amount of money, eclipsing the money that was borrowed during the 2008/2009 financial crisis. In fact, U.S. banks have borrowed a combined $164.8 billion from the two backstop facilities provided by the Fed. At the same time, the FDIC was backstopping Silicon Valley Bank and Signature Bank. Everywhere you look, the government is handing out money to the banks.

Because of all of this, there have been other reversals worth noting. The Fed balance sheet, supposed to shrink during the Quantitative Tightening process, has reversed course and is growing again. Money market funds are also growing, with $5 trillion parked there, which was a $121 billion influx during the past week.

At the same time, many banks have turned to the FHLB to borrow money. Last Monday, the FHLB system raised $88.7 billion in floating rate notes and added to that as the week progressed. Barclays calculates that the FHLB has raised $260 billion through last Thursday. The total amount of money that the FHLB has now lent to banks is $819 billion. JPMorgan has stated that this is bigger than any quarter and “is consistent with a record jump in advance demand.”

All of this is also adding to our flummoxed yield curve, with the 6-month Treasury Bill at the height providing a yield of 4.60%. This is a yield 117 basis points higher than the 10-year Treasury and 98 basis points more than the 30-year bond. So much for the value of duration. It has flown out of the window.

Then there is the Credit Swiss (CS) mess. They have offices, and are regulated in the United States, Switzerland, Britain and a wide number of other European countries. Their stock is currently at $2.01, in America, which is down from their high of 8.02. Their 12-month total return is now -74.15%. The Swiss government has already lent them $54 billion, and the rumors are flying about some kind of deal with Deutsche Bank (DB) or UBS.

All of this is seriously affecting the equity markets with, for the last year, the DJIA -8.32%, the S&P 500 -12.24% and the NASDAQ -16.29%. Then we have IG Corporates, HY Corporates, Municipals, and MBS bonds all widening and widening versus Treasuries.

I am telling you “The Heat is On,” and it does not look to be cooling down any day soon.

Glenn Frey characterized it well. “The heat is on, on the street, inside your head, on every beat, and the beat's alive deep inside.”

Keep going but very, very cautiously.

Original Source: Author

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.