Not Your Typical Banking Crises with Not-at-all Generic Côte du Rhône Wine
There are weeks, when I profoundly struggle with a fear that what I am about to compose might be too trivial, and not worthy of inclusion. In an absence of happiness, people are often content with an appearance of such. In the absence of noteworthy market and relative value developments, I, too, must content myself with the best that I can unearth.
And then, there are other weeks… the weeks, when I struggle to contain myself, for if I were to publish everything that is swirling in my less than stable mind, a fixed income War & Peace might be born. And few of my readers wish to endeavor reading such a monstrosity.
I would, however, venture a guess that many would like to read about, or better yet, drink a great bottle of a Magic Juice. And so, we shall, without any doubt; for we deserve a little break! We should we go today? Hmmm, I am thinking France.. Southern Rhone; I have not been there in a while. And today, we are drinking:
Le Clos du Caillou, Vieilles Vignes “Cuvée Unique” Côtes du Rhône,
Southern Rhône Valley, France 2018
Do you see “Cuvée Unique” running diagonally across the upper corners of today’s label? That’s the “clue” that tells us local winemaking legend Bruno Gaspard has specifically hand-selected a handful of high-performing barrels for his longtime friend/boutique importer. As for the raw material? This luscious red hails from vines that qualified for Châteauneuf-du-Pape AOC status when it was first classified some 85 years ago.
But, before I get carried away with this gorgeous wine, lets talk Banks, let’s talk MBS.
While it is tempting to recount the entire chain of events leading up to the collapse of two major financial institutions, it has all been done before, in minute details. To a large extent, the narrative does boil down to a confluence of factors, of which liquidity concerns is an important one.
As deposits evaporated, while the new ones became increasingly costly, those banks that had reached out for yield in 2020/2021, saw increasing NIM pressures. This was particularly the case for institutions with a less diversified deposit base (and a higher share of uninsured deposits). As investors and rating agencies began noticing this troubling development, they singled out those institutions, where the pressure was particularly concerning.
The rest was the tail of a self-fulfilling prophecy and a race to the bottom. As depositors started to get nervous, so did the management teams, leading to sudden moves, such as asset sales to improve the liquidity situation, as well as equity raises. These moves did supply some meaningful liquidity, but by that point, it was no longer about cash.
Depositors saw these moves as a conformation of their fears and voted with their feet. At the height of the SVB crisis, for example, several billions of deposits were fleeing every single hour. By that point, the media jumped into the fray, and no amount of AFS portfolio sales could plug that leak.
While all banks have experienced liquidity tightening since the dramatic rate increase of the last 17 months, the degree of this deficit varied massively, with most banks in a perfectly solid position. While the damage of this crisis has been limited thus far, its implications on MBS will be widespread and long lasting.
Firstly, as we mentioned before, the banks are going to ensure that they are not next on the hit list and are likely to take full advantage of the newly created emergency backstop – Bank Term Funding Program, which was launched on Sunday the 12th of March. Since then, banks already borrowed almost $12 billion via the BTFP.
This $12 billion is a child's play in comparison to the staggering increase in a traditional liquidity borrowing method – the discount window. Prepare to be amazed: during the week prior to the SVB collapse, only $4.58 billion has been borrowed via the discount window. Through Wednesday, the 15th, banks have borrowed an astounding $158.8 billion.
We have seen a similar magnitude of borrowing by banks 15 years earlier, during the GFC. Back then, however, the record high was only $111 billion. Add to this yet another $142.8 billion borrowings by the two banks taken over by the FDIC, and you get a truly remarkable number in the vicinity of $307 billion of the total liquidity boost.
Now, much of this funding is rather expensive for these banks. Unless these are promptly repaid, we do see a mounting pressure to sell portions of the AFS holdings. It is too early to quantify this notion, since the banks are also likely to tighten their lending programs, thus freeing some additional liquidity.
This tightening in lending efforts, will result in a reduction in total loans produced, and is likely to lead to lower MBS supply starting in June. While we do expect that much of this decline will be offset by an increase in the securitization rate, we still expect a dire MBS supply situation, which is especially the case in the 15-year space..
Many commentators emphasized the point that as a potential source of MBS demand, depository institutions are dead. While this is clearly true in the short run, it does not have to be this way for very long. First of all, let’s be honest – this was a scary week. And while it might feel that the worst is over, even if it is (which may not be so), too many "players" have been sufficiently traumatized.
Equity investors, holding shares in many banks, especially the ones in the eye of the storm, have been hurt in a big way. Corporate CFOs have gained many gray hairs (or lost hair altogether) through this ordeal. Corporate cash managers have been reminded that diversification is the king, and that nothing (not even banks deposits) is truly riskless.
In that light, and, given the currently heavy cash concentration in simple T-bill ladders (that have been put in place to take advantage of the crazy high short rates), cash managers may be compelled to broaden the base of depository institutions they are dealing with.
They will be increasingly tempted to reallocate money away from the Treasury market, when the front end of the curve is no longer as attractive, depositing the funds with more banks (that are perceived as being rock-solid). Clearly this action will increase the inflow of deposits.
And above all, the general public has been scared enough to re-learn the meaning of the four magic lifesaving letters: FDIC, with the phrase “how safe is my $$ in the bank”, or variations of the theme, topping the Google search "charts" last week (yet still behind the searches related to the release of Taylor Swift’s four new songs last Friday).
The financial fear of the general public invariably results in an increase in deposits. We always believed that the market underestimates the risk aversion of the broader population, especially at times of financial stress. Since for most people, insured deposits are the only type of deposits that they are concerned with, the potential inflow of cash into the banks is a very real possibility.
In fact, the large depository institutions are already seeing an increase in deposits. As the diversification argument plays out, and the market gains confidence that the remaining banks are “money good”, smaller institutions will get their share of deposit increases as well.
Thus, we do expect that if short rates decline, the "deposit drought" could end almost as quickly as it stated. To be sure, banks will not be flushed with cash as they were in 2020/2021, but they will no longer experience such a shortage of liquidity. And given their otherwise strong balance sheets, bank will likely return to some MBS feasting.
To be sure, they will return a lot more risk-averse, and with much more limited appetite for duration and negative convexity. Their romance with 30-year pools will be largely over, in the universe of rich and powerful institutions. And yet, with the 15-year supply in the negative territory (even if rates), they will have to turn to CMOs. Indeed, the next return of Banks will mark the era of Collateralized-Mortgage Obligations.
For now, we are sitting on historically attractive (and considerably so) MBS valuations, and few investors, who are willing to take advantage of it. When the run-on banks fear subsides (and we believe it will by April Fools Day), we will see a meaningfully different (and much less inspiring) relative value landscape in the MBS space.
And now, we are back in France!!!
This wine will make you forget the boring the “generic” Cotes du Rhone label since geographically, stylistically, texturally—this is Châteauneuf-du-Pape at half the price, and this 2018 might be my favorite bottling yet. Clos du Caillou is located in Courthézon, a village within the Châteauneuf-du-Pape growing zone, and we always enjoy sharing its “stay off my lawn” origin story: In 1936, 40 years after the property was established as a hunting lodge, France’s AOC governing body approached Caillou’s then-owner with the intention of incorporating it into the ‘new’ Châteauneuf-du-Pape appellation.
The officials were met with armed resistance—Caillou’s owner had no desire to join the governing ranks of anything, let alone a wine appellation. This brazen act originally excluded the estate from the AOC and essentially carved out a sizable chunk of CDP’s border. Today, it continues to be an ‘unclassified’ section in what is otherwise some of the most prized vineyard land in the area.
About 20 years after “the lawn altercation,” Clos du Caillou was purchased by the Pouizin family, who stowed the guns, started planting vines, and began making wine. Over the next four decades, Claude Pouizin made Les Clos du Caillou a household name for premier Châteauneuf-du-Pape. In 1996, the youngest of his three daughters, Sylvie, inherited the operations. At the time, she was living in Sancerre with her husband, Jean-Denis Vacheron (the Vacherons make some of the Loire’s finest wines). After the tragic passing of Jean-Denis in 2002, Sylvie pushed forward and maintained the estate’s legacy with the help of lead winemaker Bruno Gaspard.
Driven by Grenache grown in the pebbly, sandy soils of the zone, “Cuvée Unique” is a special Côte du Rhône selection created each year from premium old-vine lots and, subsequently, the best batches in the winery. The 2018 is a blend of 85% Grenache, 8% Syrah, 5% Carignan, and 2% Mourvèdre that aged for 12 months in a mix of old foudres (large oak casks) and tanks. To enhance purity and terroir expression, the final wine was bottled unfined and unfiltered.
The full-bodied palate is a trifecta of unabashed richness, polish, and refreshment; an opulent tour de force that magically avoids palate fatigue. In short, it’s a pure, hedonistic snapshot of the Southern Rhône.
Thanks so much and Enjoy!
Kirill A Krylov, CFA, PhD
Distressed Debt and Special Situation Specialist
1yAwesome write up and a great wine Thank you