Silicon Valley Bank: Loans and Haircuts
SVB loans takes a massive haircut and First Citizens gets the reward.
“Serious haircut for SVB and FDIC; First Citizens does a happy dance!”
The good news on the SVB transaction is less uncertainty around the fate of a major bank that would see value destruction of the loan book and more depositor outflows the longer this dragged on.
The $16.5 bn discount is an eye-opener at 22.9% to the $72 bn loan balance cited.
The reality is that the discount would have wiped out the entire equity capital base at SVB, but the unrealized securities losses at legacy SVB were almost as large.
The discount on loans and the securities losses means the SVB capital base was wiped out two times over.
The FDIC press release hit my inbox after midnight as the questions on the potential sale of SVB loans to First Citizens Bank of North Carolina (parent ticker FCNCA) gave an objective measure of what a fire sale of illiquid loans might look like if other regional banks get closed. We now have an idea.
We had been looking at the fear that would be cropping up around the carrying value of SVB. We posted some ideas on loan fears in our weekly last night (see Footnotes and Flashbacks: Week Ending March 26, 2023). We did not expect an answer so soon (couple of hours) after we posted.
That loan book price represents a major haircut and a massive discount. This could have the ironic effect of encouraging hope that there will be even more buyers on the other side of regional bank problems. Whether that will reassure uninsured depositors remains to be seen. The flip side of that half full spin is the fear that the loan books are badly mismarked. That will then return to the same debate that the market has been working through. That is, SVB was a mismanaged outlying mess with a unique customer profile.
FCNCA gets a big response out of the chutes…
FCNCA is already up 46% as we get ready to post this note. That is an even more impressive replay of what New York Community Bank saw with its Signature deal. The big discount and FDIC support allows for very rapid growth of earning assets at a steep discount and the deal can be pursued with backstop liquidity support.
Some SVB scenario fears are relieved….
The big fear for an SVB customer and the broader peer group of regionals (and their shareholders and depositors) watching this was the potential sale of some or all of the bank dragging on too long. Liquidation was also an option. That would do damage to the customer base and then defections would accelerate alongside credit erosion of the loan book.
As it stands now, this should be a major relief for SVB clients and ease some of the angst in regionals. The scale of the deposits and loans in the deal is a massive move of assets for FCNCA and the FDIC. The troubled and underwater securities portfolio stays behind with the FDIC.
We always wondered about the unfunded loan commitments and the related uncertainty of loss of liquidity over time for clients and what damage that would do if SVB stayed in a state of crisis that destroyed even more value. That would suck liquidity out of the system as some borrowers started flunking covenant tests even as they took down deposits. That process was already underway for the borrowers seeing cash burn rates.
The theory now is that First Citizens can move into the next round of due diligence with a big discount and substantial FDIC backing on liquidity and loss sharing as they try to “clean up Dodge City.” The 10-page presentation on the morning call was more or a less a commercial for how good the acquisition will be for First Citizens. We already see that in the stock price action this morning.
The deal in context macro vs. micro…
The announcement was good news for the regional bank sentiment to not have this uncertainty around the fate of such a large bank, but the price and the haircut on the loan portfolio was not pretty. The $16.5 billion haircut on the loan portfolio of around $72 billion in loans (per the press release vs the year-end balance of almost $74 bn) was a hefty 23% haircut, and that gives the market a sense of how weak the loan book was vs the carrying value. Being a distressed seller of loans is not a great place to be for a small or mid-sized bank.
The super bears can take that haircut and start telling a solvency story while attacking capital adequacy, but the idea that (very!) illiquid assets get a steep haircut in a fire sale is hardly new. That takes some of the edge off the ugly sale price. It is also a reminder that internal loan quality rating and relative risk can be very different than what is represented in the financials.
Risk symmetry with loans is supposed to be lower given the secured structures, but many services operations are asset lite. The credit scoring internally on many SVB assets was undoubtedly axed and tied into future prospects more than current cash flow and debt service risk. We just cannot tell from the outside looking in.
The buyer is taking a big bite with a lot of FDIC support…
With respect to the buyer, “First-Citizens Bank & Trust Company” is a bank subsidiary of First Citizens Bancshares (FCNCA), which had an equity market cap of $8.4 bn at market close Friday. The conference call on the deal this morning went through the deal mechanics, and we found the call more informational on the line items than detailed on integration game plan. They did reassure questioners that the deal is significantly accretive which is what stockholders would naturally expect after the buyer of Signature saw a great response.
For First Citizens, good news, a big challenge, and big opportunity…
As we saw with the purchase of Signature by New York Community Bank (NYCB), the hope is that a big discount (very big) and a material acquisition of this extraordinary scale in percentage terms (adding $72 billion in loans for essentially a doubling of the loan book). Before open, NYCB stock was up by 38% since March 17 before the acquisition of targeted Signature assets.
For First Citizens, the deposits of SVB may come with a hot money asterisk on the deposit base, but the $56 bn in deposits from SVB are added to $89 bn at First Citizens for $145 bn total. First Citizens will face a loan to deposit ratio that is now higher, but it is notable that FCNCA comes with a larger deposit base than what it is acquiring.
On an historical note, another long-ago regional bank in North Carolina named North Carolina National Bank (NCNB) started making acquisitions in the 1990s and rolling up larger entities. That bank picked up a few choice deals along the way to become NationsBank and today the operation is known as Bank of America.
That is a tough act to follow, but the smaller well managed banks such as FCNCA have been rolling up entities working with the FDIC. This was not the usual roll-up, but it may inspire other regionals to highlight that they would be the buyers and not victims.
There will be more filings on this deal to look through. We will follow up. The bank wonks will undoubtedly be all over this. For us the question will be whether the market looks for winners and losers and not tagging the whole regional sector as weighted toward losers.
The rational conclusion is the collapses will be very rare since asset quality has been good and liquidity from the regulators has been readily forthcoming. We will still have credit contraction but there should be less panic.