Winners & Losers in the New Gilded Age
March 20, 2023 | In times of financial crisis, stuff happens on the weekend. But in watching the sale of Credit Suisse (CS) to UBS Group AG (UBS), we are reminded that 2023 marks the end of twelve years of quantitative easing (QE) and related distortion of the loan and bond markets. During QE, the FOMC explicitly embraced inflation. Credit loss rates went negative and asset prices soared, making any bank, nonbank or fintech large or small seem like an investment grade proposition.
The largest part of QE came in 2020 during the dislocation caused by the COVID virus developed in Wuhan, China. The COVID crisis unleashed a torrent of progressive nonsense and related financial giveaways that saw Congress discard any pretense of fiscal probity. Crypto tokens replaced real assets as investment vehicles while government officials responsible for financial institutions spent their time talking about global warming and ESG.
Mark Twain called Washington ''the grand old benevolent National Asylum for the Helpless'' in his classic "The Gilded Age." What would Twain say of Washington today? Even as the FOMC sends the US economy into a new period of uncertainty, the Administration of President Joe Biden is populated with an army of articulate incompetents led by former Fed Chair and now Treasury Secretary Janet Yellen. Although none of these platonic guardians recognized the approaching bank crisis of 2023, the readers of The IRA were forewarned.
Lee Adler at Liquidity Trader puts the current situation succinctly:
“The Fed is playing a new game. The problem is that nobody knows what the rules are, not even the Fed. In fact, nobody even knows what the game is. Especially not the Fed.”
With the end of QE, asset quality and credit are now again real-world concerns as default rates revert to the mean. The past few years of QE and exemptions to Basel have been very friendly to the regionals/super regionals, but that’s coming to an abrupt end even if Congress passes no new regulations for banks.
Source: FDIC/WGA LLC
During the period of QE, a lot of narrow niche banking businesses soared. Business customers migrated to smaller banks to get better service. Many mortgage lenders, for example, used Signature Bank as the custodian for escrows and other uninsured deposit balances related to mortgages. Startups used Silicon Valley Bank for payroll and other business services. But now that basic business of custody and payments is flowing back to the larger money center banks.
Over the past several days, the Federal Deposit Insurance Corp brokered the sale of part of Signature Bridge Bank to New York Community Bank (NYCB), which acquired Flagstar Bank last year. NYCB’s Flagstar Bank NA units purchased assets of approximately $38 billion, including cash totaling approximately $25 billion and approximately $13 billion in loans. This means most of Signature Bridge Bank is still owned by the FDIC.
NYCB assumed liabilities approximating $36 billion, including deposits of approximately $34 billion and other liabilities of approximately $2 billion. Significantly, the NYCB is working on an agreement to sub-service the legacy Signature multi-family, commercial real estate (“CRE”), and other loans it did not acquire. NYCB also acquired Signature’s wealth-management and broker-dealer business. Most of the deposits assumed by NYCB are related to the wealth management business of Signature on both coasts.
The fact that NYCB did not acquire the Signature multifamily and commercial assets illustrates our earlier point that these loans are essentially unsalable. Because of the COVID-era rent control legislation passed by the New York State legislature in Albany, rent stabilized multifamily properties in New York are impaired assets. NYC landlords cannot increase rents to reflect rising operating costs or refurbishment of apartments. These moribund assets really cannot be financed by banks and will ultimately be purchased by less reputable owners who will seek returns by reducing services, maintenance and other expenses.
“Flagstar has gotten a very fair deal,” we told Steve Gandel at the Financial Times. “And it doesn’t surprise [us] that the FDIC is going to have to take a loss, in part because of the low quality of the remaining assets.”
Meanwhile in Europe, UBS has cemented its monopoly status in the European banking market by taking out the last major competitor in CS. Of note, the UBS purchase appears to include the Select Portfolio Services (SPS) servicing unit of CS as well as the Ginnie Mae advance book and the non-agency mortgage servicing right (MSR) owned by CS.
CS had been attempting to sell the SPS business, but after an auction process concluded last month there was no announcement of a winner. According to Inside Nonconforming Markets, Utah-based SPS was the largest residential servicer of nonprime mortgages at yearend with an estimated portfolio size of $141.0 billion and a market share of 42.9%. It looks like UBS
Looking at the Eurozone, UBS is now the dominant bank in Switzerland and the only franchise in Europe that seems to have the capital and earnings to prosper. A reader named Paul in Europe puts the situation succinctly. “Let’s face it. There are six global investment banks left: JPM, GS, MS, BAML, UBS, Citi. UBS is the only remaining powerhouse in Europe and now is a monopoly in Switzerland. The devil is in the detail. Use weakness to accumulate UBS.”
Our flutter in CS did not generate the desired outcome, but we are going to take the UBS shares and accumulate more on weakness -- assuming the deal closes. The table below summarizes the banking landscape in Europe. Unlike the US, in Europe zombie banks don’t die, they just become part of the background like the ornate buildings in European cities. Some statistics on UBS and its EU peers is shown below.
While our trade on CS back in January was not successful, we tend to like UBS as a long-term holding. Also, one of our favorite mortgage lenders, Western Alliance Bank (WAL), bounced into the low $30s after trading in single digits. We’ll be publishing a detailed analysis of the post-close NYCB in the next Premium Service issue of The Institutional Risk Analyst.
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