full image - Repost: The IntraFi Manifesto (from Reddit.com, The IntraFi Manifesto)
Mining:
Exchanges:
Donations:
In 2002, the Promontory Interfinancial Network (PIN) was created to help large depositors receive higher FDIC limit protection (millions of dollars worth) through a system called the Certificate of Deposit Account Registry Services or CDARS for short. This system became relatively popular and wasn’t a massive strain on liquidity or redemptions as it could ladder CDs that were easier to time and not “on-demand.” These deposits were somewhat segregated and considered brokered or reciprocal deposits, meaning the receiving end bank was showing the deposit as not theirs.To help illustrate, you, as a high depositor, go to Fancy Bank with $1 million and request additional FDIC protection. At that time, FDIC limits were $100,000. So, Fancy Bank obliges and takes your deposit but turns to Mom Pop Bank, Little Guys FTW Credit, and other small banks under much less regulation restraints to place $100,000 at each for FDIC protection. It’s in the form of varying CDs so these banks know when assets may leave. Additionally, it’s recorded as a reciprocal deposit, meaning the small bank does not own that deposit; another bank does. In our example, Fancy Bank.You want the warm and fuzzy promo reel for community banks, you got it:https://youtu.be/XkifMY8TmEwLife is good. Fancy Bank has a happy, calm depositor. Small banks are happy as they get new deposits. Growth continues. Then, Amazon came out with two-day shipping in 2005. Later, at the January 2007 Consumer Electronics Show, Netflix announces its on-demand streaming platform. It is reported around this time that U.S. Banks had roughly $67 billion in reciprocal deposits, most likely leveraging this network. In a fictitious conversation following the 2008 financial crisis that saw many depositors demand the same instantaneous access to their deposits as they get to their packages and movies, PIN board members said to each other, “Certificate of Deposits are the new DVDs. We need to go streaming!” They launched the Insured Cash Sweep (ICS) service in 2009, granting depositors in their network significantly faster access to their deposits. It wouldn’t matter as banking deposits continued to grow; the network could always be balanced. Deposits would continue to climb, never leading to net redemptions… right? By 2020, it was estimated that there were roughly $353 billion in reciprocal deposits, according to the FDIC report.Deposits steadily grew year after year with marginal stress on the system, even during the financial crisis. However, it wasn’t as “on-demand” then as it is now. Enter… the pandemic. Let’s ignore all the nuances that occurred and focus solely on bank deposits. Deposits in the banking system surged from $13.2 trillion in January 2020 to $18.15 trillion at its peak in April 2022. Again, life is good. Deposits, which fuel bank growth, are ballooning. To give a non-financial example, let’s look at Peloton. During the pandemic, they believed it was the new norm of limitless demand for overpriced exercise equipment, fiercely charging into the next frontier of fitness. Obviously, with the benefit of hindsight, that didn’t happen. They over-extended and have staved off bankruptcy, watching their stock dive from over $160 a share to now under $10.Many banks surely did the same. Deposits surged across the board, it was time to make agressive moves. While all the bank runs are stealing the headlines in 2023, the FDIC report from December 2022, shows an unsettling picture for these banks that partook on the liquidity party bus, with deposits declining and loans surging. Deposits leaving the system are primarily non-FDIC insured deposits (values now over $250,000), which seem to be flocking toward higher-yielding money market funds and treasury bonds. And again, this flight started in the middle of 2022. A flight that seems to be ignored and focused solely on the large banks that cater to this market. However, it’s happening system-wide. Most troubling is the explosion in loans with this backdrop. According to the FDIC’s report (https://ift.tt/DwqZ6eI ), loans jumped $1 trillion while non-FDIC insured deposits fell $226 billion. For 2023, this has accelerated, with nearly $250B already leaving the system within less than three months. Don't be mistaken. This is what the Fed wants. They are trying to increase unemployed people to "rebalance" the labor markets and get inflation down to an arbitrary 2%. To do this, they want to decrease cash. They are. Depositors are turning over dollars for bonds and money market funds. As this occurs, the money supply is shrinking too.Take this information now with the context of Silicon Valley and Signature bank failures… Ruh Roh. Loans are illiquid. They aren’t currently helped by the fed’s liquidity boost to lending on par value of their security holdings to help give banks temporary cash. Temporary being the key word. The Feds surely know this isn’t temporary. They’re interest rate hikes are working. Money is leaving. It is simply more observable at the banks that cater to this money, like First Republic as well, which is insolvent. With the Fed continuing to excessively hike rates, it will continue to widen this gap. Bank deposits will continue to leave until rates normalize in line with what banks can compete with, which would take year or more for loans to mature and banks to align their assets and liabilities better. We don’t have that kind of time with the current flight of funds. Small banks are just now starting to see the flights (https://ift.tt/As4I9Cz), although most seem to flock to the top 15 banks, not affecting the system, but affecting the small banks.This brings us back to the Promontory Interfinancial Network, or IntraFi as they now call it. Everyone loves a sexy re-brand, which ironically happenned in 2020. Let’s jump back to our Fancy Bank example. You, as the large depositor, now decide, “hey, Fancy Bank, I can get 4.6% in a money market fund right now. That’s cray. I’ll just take my deposit and do that, thank you.” Fancy Bank returns to their small banks and says, “Give me my depositor's money. It’s not an issue, as you’re reporting these as reciprocal deposits, which everyone can readily see.” But, Little Guys FTW’s CEO (most likley a stubbled beard man with goatee and long mustache, rounder in stature, jeans and boots for sure, potentially grey suede cowboy hat, undoubtedly there to help his local ranching community)stands up and says, “Actually…”In 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) was signed. Little Guy FTW was excited about “Section 202,” which allowed for “well capitalized” banks to remove this silly "reciprocal" language nonsense and count them as core deposits, relieving additional scrutiny from regulators. Again, the system had been around since 2002 and had never experienced declining banking deposits. Therefore, net-deposits into the network continued to outpace any net-redemptions. But then, 2022 inconveniently happened, with system wide banking deposits falling continuously.According to IntraFi, nearly 3/4ths of their network members have less than $1 billion in assets. To the feel-good promo video above, that’s great. And it really is great. It’s done good, for sure. But, these last few weeks have brought an entirely new dynamic to the banking sector. Once “armageddon” ratios that seem inconceivable and massive capital buffers safe, are now looking less comforting. Depositors are now scrutinizing their bank’s books and moving funds for more attractive alternatives.I don’t blame them for not being concerned with it being at over 20% of liabilities. It seems almost impossible for a system as a whole to see that kind of redemption or stress. However, from the US banking deposit peak, we've already seen a 3.6% decline. Will it continue? At that time, IntraFi had seen nothing but an increase in assets, which are now estimated to be over $500 billion, potentially close to $1 trillion. We can't see it, thanks to Section 202. As of March 15, 2023, total US bank deposits were roughly $17.5 trillion. If we assume the top 15 banks stayed relatively flat since December 2022, they were looking at roughly $7.5 trillion in deposits that the reamining system could have heavy exposure to the network. So IntraFi is making up somewhere between 6% - 13.3%. That’s the whole system. We’d have to assume closer to 20% for all the smaller banks that want to stay under the threshold. Again, we can’t find reliable numbers as Section 202 removed the ability to see these deposits.But, let’s look at what we can see, referencing the recent H.8 release (https://ift.tt/nGAET9U). March 15, 2023 showed an unusual drop in deposits for small commercial banks after what had been a relatively stable year before, falling from $5.521T in deposits in Feb 2022 to $5.468 T on March 15, 2023. Loans in that period went from $3.9T to $4.5T. So, a 1% drop in deposits with a 15% jump in illiquid loans. In terms of small banks overall buffer, it sits at about 15% between reporated loans and deposits, potentially the size of IntraFi deposits. In any other scenario, 15% looks wildly safe. But, what happens when IntraFi pulls large swaths of deposits from the small members, which could start seeing other deposit issues. Remember the promo? These guys were sold to live off of it. Those small institutions will have the highest rate of loans to deposits, making them insolvent as deposits flee.The FDIC has blown the majority of its cash load on Silicon Valley Bank and Signature Bank. If First Republic and others fall, what funds will be left? The regulators are selling assets significantly below their value, evident by First Citizens stock surge on the announcement. Congrats to the Holding family, seriously their name, you can’t make this up, having one of the largest jumps in wealth they’ve seen. But, seriously, you should have done the “Holdings Company” or something. That would have been incredible. I digress.But, what happens when people learn the FDIC has no funds. As they approach their bank with the latest ABC news headline, they’re bank said, “your deposits are safe. They’re FDIC insured!” … “But, the FDIC doesn’t have any money…” You get the idea. Surely the FDIC will issue bonds that the Fed arbitrarily buys, but the damage is already done at that point.All this being said, many banks have an extraordinary amount of liquidity and will be fine. They’ll benefit from this chaos if it occurs, as they’ll wind up substantially larger than just months before. First Citizens doubled in size overnight. From the hundred or so banks I’ve had to review over the last few weeks, I would say probably 90% are fine. But, can the system handle 10% chaos, especially when looking at the smaller banks? Sure, the FDIC can stomp in and make demands to a massive bank with $100 B in deposits. What is it going to do with 500 community bank failures all with $1 B deposits?Ultimately, the US banking system is seeing a liquidity crunch unlike what it’s ever seen before, except to maybe 1929, which lead to the creation of the FDIC, definitely a good thing. At that time, the Fed was focused on saving the dollar at any cost. The lack of FDIC’s existence could probably be credited for total destruction of the economy, as savings were gone and banks had to rebuild. But, ironically, this liquidity crunch is now being driven by the non-FDIC insured deposits. Depositors never worried before, but they are now aware of their bank’s position, which is good thing. But this transfer of money is just beginning. As the Fed keeps hiking at such a pace, currently priced to do another 25 bps next month, banks will be unable to compete with treasuries and money market funds. At some point, the system will temporarily break. Banks won’t be able to balance and many will be forced to realize some large losses held in their securities. Other banks won’t have enough securities to sell and be rendered insolvent. I do not doubt the Fed will come in with another liquidity bazooka and maybe even potentially dropping rates if it comes to this, trying to reset the system. But, will we see the explosion of inflation again? It seems we’ll be caught in an endless boom and bust cycle, spurred almost soley by the Fed, which was initially created to try and stop or ease market cycles, eliminating the boom and bust cycle. Again, more irony. And we know how well their track record is.So, as the high depositors continue moving funds, it only seems inevitable to eventually put stress on the IntraFi network, most likely for the first time in its history. That would in turn put stress on community banks, which may then see their own stresses from their truly non-reciprocal deposits that may seek shelter in the majors like J.P. Morgan and Bank of America if remaining in the banking system.Oh, and did I mention the issues in commercial real estate right now, which banks are predominantly holding the loans on? I suppose we'll save that for another day.And to part, before you prophesy bitcoin as the only investment, I believe treasury bonds will perform best over this scenario if it plays out over the next year. I hope it doesn't. The market sees zero chance with the VIX below 20, which seems bananas. Maybe institutions are trying to stack their books as they did with credit default swaps in 2008? Allowing us to blindly enjoy a calm before the storm... or it could all end up being nothing.Cheers
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