KRE: Drying Liquidity Will Test Regional Banks This Summer

seekingalpha05-07

PM Images The FDIC's bank failure list continues to grow, adding Philadelphia's Republic First Bank at the end of last month, not to be confused with First Republic. In recent years (since 2021), I've...

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In recent years (since 2021), I've...</p>\n\n<a href=\"https://seekingalpha.com/article/4689945-kre-etf-drying-liquidity-will-test-regional-banks-this-summer\">Source Link</a>\n\n</div>\n","source":"seekingalpha_fund","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>KRE: Drying Liquidity Will Test Regional Banks This Summer</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nKRE: Drying Liquidity Will Test Regional Banks This Summer\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-05-07 10:23 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4689945-kre-etf-drying-liquidity-will-test-regional-banks-this-summer><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>PM Images The FDIC's bank failure list continues to grow, adding Philadelphia's Republic First Bank at the end of last month, not to be confused with First Republic. In recent years (since 2021), I've...</p>\n\n<a href=\"https://seekingalpha.com/article/4689945-kre-etf-drying-liquidity-will-test-regional-banks-this-summer\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"BK4535","symbol_name":"淡马锡持仓","start_time":0,"source_url":"https://seekingalpha.com/article/4689945-kre-etf-drying-liquidity-will-test-regional-banks-this-summer","article_id":"2433295423","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1222778351/image_1222778351.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2433295423","pubTimestamp":1715048630,"sourceInfo":{"source_id":"seekingalpha_fund","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"PM Images The FDIC's bank failure list continues to grow, adding Philadelphia's Republic First Bank at the end of last month, not to be confused with First Republic. 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In recent years (since 2021), I've warned investors of peculiar risks in the US banking system that I feel are widely underappreciated. Since banks began to fail last year, I've been particularly bearish on regional banks such as those in the ETF (NYSEARCA:KRE). I covered that fund last August, with the view that more would fail as the Fed seems OK, allowing the banking industry to consolidate toward larger banks. Two additional banks have failed since then, with a few coming very close to failure, such as PacWest. KRE has risen by 10% since I covered it, which, although it is not negative, is also not a particularly high return for its level of volatility and is not the recovery that many investors had hoped for. I believe it is an excellent time to cover the fund and its macroeconomic backdrop. Bank Liquidity Remains Precarious The most recent bank failure did not garner the media attention as the last, likely as more investors feel the market has stabilized. There is some truth to that, but the fact is that most banks are not solvent if all of their assets are accounted for at their fair value. That is, if we account for securities assets held to maturity at their fair value and loans (primarily non-agency mortgages), the unrealized loss on such is about equal to the total book value of equity in banks. Total unrealized losses are around $2T, with total equity at ~$2.3T, implying many banks would have no, or very little, value if they liquidated. Generally, a bank's unrealized liabilities will decline over time, although around 15-30 years (given most unrealized losses are in 30-year mortgages), and that figure will rise if long-term interest rates do. KRE rapidly rose by around 25% in value toward the end of 2023 as long-term interest rates showed a strong reversal. However, since then, long-term rates may have continued their upward trend. See below: Data by YCharts Since interest rates were so low for so long, it is easy to assume that they will inevitably reverse. Firstly, it is not true that the Federal Reserve's \"rate cuts\" will impact long-term rates, which are set by the market. However, these rates are likely impacted to a degree by QE and QT, in which the Fed buys and sells long-term bonds to create and destroy liquidity. Still, the most significant pressure on long-term rates is likely from long-term inflation expectations. That is not the immediate inflation rate but what the market thinks inflation will average out to over the next decades. This is a particularly tricky issue as inflation usually is around 2%. However, with the national debt accelerating as interest rates rise (creating a positive feedback loop), it seems pretty likely that the US dollar will experience significant inflation over the coming decades. We're already seeing this in the Japanese Yen, and I believe the US dollar will follow the fiat currency devaluation trend seen in the Yen. Keep in mind, total interest on the national debt is already notably higher than total military spending. Of course, such a monetary crisis may be delayed for some years. That said, I believe decades of low infrastructure growth and labor issues also contribute to high inflation today. The pandemic highlighted this issue, but with inflationary signals rebounding, it seems to be a growing chronic issue that I expect will stop the Fed from doing meaningful rate cuts unless there is a significant market crash that creates significant temporary disinflation. So, although inflation has a limited direct impact on banks, it has immense indirect effects. Primarily, it causes long-term fixed-rate securities and loans to decline, pushing long-term rates higher. For example, a ~25-year Treasury security today will lose around 24% in fair value for a 1% increase in its interest rate (seen in the duration of the ETF EDV). The opposite is also true. A rise in long-term rates would rapidly erase the unrealized losses in banks and create unrealized gains on loans and securities minted at today's higher rates. A significant decline in long-term rates would undoubtedly dramatically aid failing banks today. That is why I'm reluctant to short-sell these banks, although I believe rates are more likely to devalue them than reverse. I believe it is essentially a myth that unrealized losses do not matter. I've heard that many times, but it is an accounting issue. For one, unrealized losses are the primary cause of all recent bank failures, with most failed banks boasting high \"CET1 ratios\" and then failing due to insolvency as unrealized losses were far more significant than their \"Tier 1 equity.\" Unrealized losses matter if liquidity also declines. As a bank's liquidity declines, it needs to sell assets and realize those losses, causing its insolvency to become more apparent, often creating a negative feedback loop (where people pull money from low-solvency banks). Deposits and the Federal Reserve drive bank liquidity. Since last year, smaller banks have increased deposits more than larger peers by offering far superior savings account rates. Small bank depositors are often wealthy individuals and businesses that will move their money to banks with the best rates. In contrast, larger bank depositors are more often the general population, ironically more loyal to larger banks that dramatically underpay savers. I expect that will change as the Fed rate remains so high. Total bank deposits fell significantly at the end of 2022 and the beginning of 2023 as QT began. Since then, overall deposits have been stable, but there has been a continued trend away from demand deposits toward time deposits, such as CDs, which pay much more than most savings accounts. See below: Data by YCharts Interestingly, the trend toward large time deposits in both large and small banks is also slowing. Both had risen significantly throughout 2023 but are now stagnating, while other deposits (i.e., demand deposits) are also stagnant. To me, that is one indication that bank liquidity is on the verge of slowing again. Bank liquidity today is driven by the Federal Reserve. The personal saving rate (savings to income) is meager today at 3.2% and continues to slide, implying that households are still struggling with inflation or can't moderate spending. Thus, household savings are becoming unimportant to banks compared to the Fed's huge impacts from QE and QT. The Fed's total balance sheet often measures that. However, a portion of that balance sheet is \"reverse repurchase liabilities,\" which is excess bank liquidity temporarily lent back to the Fed from banks (which lends to banks). The reverse repurchase liabilities segment skyrocketed toward the end of the last round of QE as large banks had too much cash but lacked the equity to lend it out. Subtracting reverse repurchase agreements from the balance sheet, we get to a close approximation of the \"Net liquidity from the Federal Reserve.\" A rise and fall in this figure will ultimately drive bank liquidity. Data by YCharts By this measure, we can see that the Fed deployed liquidity to banks in 2023. Although its balance sheet fell, its reverse repurchase liabilities fell faster as banks drew on that spare reserve created in 2021. That \"reserve\" was around $2.4T at its 2023 peak and is just $473B today, meaning banks will not have this backup liquidity source in the future. At the current rate, reverse repurchase liabilities will run out over the summer. Thus, it is unsurprising that the Federal Reserve surprised the market by announcing it would slow QE in June. In other words, the Fed will slow the pace it is reducing its assets (QT - \"liquidity destruction\") as banks lose access to the excess liquidity. I know this can sound complicated because monetary policy terms are hardly straightforward. To simplify, the Fed gave too much money to banks from 2020 to 2022. Banks used that money to buy low-paying securities and loans (bad investments) that have lost considerable value since. Now, the Fed is trying to pull that money back from banks, but because the investments have lost value, it cannot do so without creating a solvency and liquidity crisis. Thus, it is slowing the pace at which it removes liquidity in hopes that it will slow or stop future bank failures. Will the Federal Reserve Save KRE? In my view, the Fed is not interested in savings banks that made bad bets or can't keep depositors but in doing the minimum necessary to stop a systemic banking system collapse, which, based on solvency levels, would happen if liquidity were removed too fast via QT. However, the Fed is walking an increasingly thin line between doing too much and exacerbating inflation issues or doing too little and opening the door to a liquidity crisis. With total systemic debt so high (public and private), it is tough to manage that situation without a strengthening economic base. I believe this situation would become uncontrollable if loan losses grew too quickly, as there is no legal way for the Fed to cover those losses (without congressional and/or executive bailout plans). Small bank loan losses are creeping up—notably, commercial property loan delinquencies are a high portion of assets for many regional banks. See below: Data by YCharts Commercial property prices have declined over the past six months, now around 22% below their all-time high. Commercial property prices are ultimately inversely correlated to mortgage rates, so the small respite from losses we've seen since 2024 is likely the result of the decline in mortgage rates at the end of 2023. Mortgage rates have rebounded, adding pressure to the commercial property market. I believe a \"soft landing\" for the banking system is very unlikely. However, I think the Federal Reserve aims to ensure a soft landing for the large banks that most Americans put money in, trying to isolate the issue to small regional banks. Based on the Fed's policy stance, I think that is clear, considering it has done the minimum necessary to slow down the problem without trying to stop it. Indeed, the banking system issues today are a result of the effort to stop the crisis in 2008, which did nothing to release the immense debt pressure that started that crisis, so the debt pressure is even greater today. Bank solvency and liquidity may look good on paper, but they are likely the worst they have been if we account for assets at fair value. Again, as cited earlier, total unrealized security and loan losses nearly equate to total bank \"book\" equity value, meaning banks have very little tangible equity left in liquidation. This issue is greater for smaller banks, which have less stable liquidity. The Bottom Line According to State Street, KRE has a \"P/E\" of 10.7X. However, as noted, that figure excludes negative-income banks, of which there are many. As we saw with IWM, actual ETF weighted-average \"P/E\" valuations can be nearly twice as high as stated if these large portions of negative income holdings are included, making the figure meaningless. Its weighted average price-to-book is 0.99X, meaning these banks have a market cap roughly equal to their book value. Again, with long-term rates so much higher than they were, bank book values are also somewhat meaningless. If all the banks in KRE held their assets for 15-30 years, they'd recover their unrealized losses. But for now, most banks' market net asset value is dramatically lower and could turn negative if loan losses grow. As reverse repurchase liabilities dry up, depending on how much the Fed slows QT, I expect bank liquidity will slow dramatically over the next four months. By then, I am willing to bet that more banks in KRE will fail. Further, I argue that most banks in KRE are at high risk of failing in the event of a significant increase in loan losses, which we may be in the first phase of. No systemic banking issues have been solved since 2023 and arguably have worsened. To me, 2023 was a preview, and unless long-term interest rates fall below 4% (without a coincident rise in loan losses), there can be no soft landing for small banks. Put simply, the Fed cannot print the trillions necessary (perhaps $1T-$2T) to aid the issue without making the core inflation issue much worse. Small banks will not have free lunches unless the economy significantly rebounds for a prolonged period.  I remain very bearish on KRE and expect 2024 to be more dramatic than 2023, depending on how the Fed manages to balance sheet wind down. The big \"X factor\" is oil prices and geopolitics, which may exacerbate the inflation-interest rate dilemma. Related, investors may want to watch how the Japanese Yen moves, as a larger decline in the Yen may be a predictor of monetary issues in most fiat currencies.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2433295423"}