When the safest assets in the world turn bad: FCNCA, SIVB, TLT

March 27, 2023, 13:00 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

First Citizens Bank (NASDAQ: FCNCA) seems to have gotten a sweet deal today.  According to CNBC they acquired assets formerly held by Silicon Valley Bank (at a 23% discount.  However, this discount may not be based on the fair value of the underlying assets, but instead on the PAR value. This exposes a massive hole in the banking system, influenced by the policies of the Federal Reserve.

The assets held at banks are traditionally secured by Treasury Bonds, with varying maturities.

However, the inverse relationship between price and yield changes the securitization ratio on the existing portfolio of banks.  For example, if interest rates rise, and prices drop, the loans secured when interest rates were high will be coupled with Treasuries that have declined in value.

The Federal Reserve has recently expressed the intent, along the lines of traditional procedures, of lending to banks at PAR value.  For example, if the Par value of the Treasuries being held is $100B, and the bonds decline to $80B, the Federal Reserve will still lend at $100B. 

The underlying notion is that if these Treasuries are held to maturity the banks will be made whole.     

Unfortunately, if the banks are forced to sell those assets, for any reason, those losses will be realized, and the losses held by the banking system now are massive.  Fortune estimates there to be $1.7 trillion in unrealized losses in the banking system today. 

The iShares 20 Plus Year Treasury Bond ETF (NASDAQ: TLT) chart below shows how massive the losses have been in Treasury Bonds since the beginning of 2022.

With this, the 23% discount that is perceived to exist in the FCNCA deal is probably much more in line with fair market value than PAR.  The Federal Reserve, FDIC, and other agencies use PAR erroneously, and in doing so create a massive liability for the Government.

No other lender would lend to a company at PAR when the current value of the assets is substantially lower, because if they did they would risk not getting their money back if there was a failure.  By doing this, the Federal Reserve is artificially inflating the perceived fair value of the entire banking industry, and it is allowing banks to operate without prudent risk controls.

The backstop that the FDIC offers now could dwindle fast if any other banks are forced to sell assets, for any reason.  The risk are extremely high.

Support and Resistance Plot Chart for TLT

Real Time Updates for Repeat Institutional Readers:

Factset: Request User/Pass

Bloomberg, Reuters, Refinitiv, Zacks, or IB users: Access Here.