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  • Writer's pictureWWH

MBS Highway Daily Updates 03/13/2023

Current position: Carefully Floating

Stocks and Mortgage Bonds are both higher to start the day after the Fed and FDIC stepped in to guarantee customer deposits at Silicon Valley Bank and Signature Bank.

How do banks make money?

Banks take your deposits, pay you a small amount of interest, and then either lend that money out or invest it at a higher rate than what they paid their depositors, making the spread between the two.

  • As an example, deposit $100k, bank holds $10k (10%). They try to make money with the rest.

  • If they pay you very little, like 0.5% on $100k, then that's $500/year in interest. But if they can make 2% on $90k, they make $1,800. Net is $1,300 on the depositor. Multiply that by tons of clients to make money.

  • Or they can invest in a longer-term asset and make money there. But there's a special provision...

  • In 2008, held-to-maturity assumptions on agencies were not subject to market fluctuations.

  • Banks are not forced to mark to market because of Dodd-Frank. Now you don't have to suffer market losses-goes under Tier 1 capital—and you don't have to show negative equity on the balance sheet.

Many banks, like SVB, bought mortgage backed securities when rates were at 3%, giving them a 2% coupon. But the Fed has hiked 450bp since last March, which was too much medicine.

  • All in response to the inflation that the Fed was responsible for creating—paranoia, Powell, and the Fed's desperate attempt to save face.

  • Continue to use the words "data dependent." This means they're driving while looking in the rearview mirror; they should call it "old-data dependent."

  • Job data: I don't know how to read it.

  • Shelter inflation is just lagging.

What's the result?

  • Because of the rapid rate hike, the money you've loaned and invested is locked into a fixed rate for a period of time. You may have to pay a bit more to existing depositors.

  • Now you have significant alternatives as to where to put your money. Now you have put your money in other places, so now you have to withdraw your money from the bank. The bank only has 10%; now they must sell assets. Show losses or come under scrutiny.

Balance sheet issues

  • We know that SVB's balance sheet of$12B. However, under the 2008 ruling, they did not need to count against unrealized $15 billion in losses due to HTM calculations. If they would have marked to market, they were not +$12B, they were-$3B.

Cramer makes things worse:

  • Cramer shines a light on this business.

  • "Wall Street is mistakenly concerned about SVB."

  • "Stock is still cheap" at $ 320.

As a result, smart investors and money managers start looking more closely at SVB. They discover:

  • Duration mismatch

  • Hidden $15B in unrealized losses.

  • Now they begin shorting the stock, which draws more attention.

  • Now people get the advice to pull money out of there.

  • Bank needs a loan to meet withdrawal demands, but they can't get it. Can't sell their stock because it's in freefall.

  • Without the ability to borrow, SVB is forced to meet draw demands and must sell assets that are underwater. Sold $21B, forced to take a $2B loss.

  • Had another $60B in agency securities.

  • Now you have a crisis run on the bank. This has huge implications.

Depositor funds were at risk

  • FDIC insures up to $250,000.

  • Real problem is payroll.

  • 93% outside of insured by FDIC.

  • Other banks come under scrutiny.

Janet Yellen gets on and says:

  • On Friday said, "The banking sector is resilient...

  • On Sunday said, "No shot of a bailout.".

What is the Fed forced to do?

  • Fed must either cut rates dramatically or create a way to buy these assets without a haircut. Fed can say it's not a loss if we get our money back over time.

  • This is why we have been so focused and so aware of the importance of an inverted yield curve. Sign that the economy is very sick.

  • Bank Term Funding Program (BTFP): allowing banks to trade in underwater securities, and the Fed is buying them at face value.

Week Ahead

The highlight of the week will be tomorrow's Consumer Price Index inflation report. The market is expecting headline and core inflation to have risen 0.4% in February and for headline inflation to decline from 6.4% to 6% and core inflation to decline from 5.6% to 5.5%. It may be difficult to see meaningful improvement within this report unless shelter costs start to catch up.

Technical Analysis

Mortgage bonds have made a bit of a move higher but have given back some of their gains and are now getting rejected at the 50-day moving average. They are still up over 80bp this morning, as there is a flight to the safety of the bond market.

The 10-year has moved back down to 3.50%. It got as low as 3.43%, but after testing the 200-day moving average and Fibonacci level, moved a bit higher. Begin the day carefully floating.


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