Bond Investors Are Wary of Being Burned in a FDIC Fire Sale

The collapse of Silicon Valley Bank and Signature Bank may not have started a bank run chain reaction, but they could potentially rock the Agency MBS, CMO, and CMBS markets with $114 billion in the bonds that the Federal Deposit Insurance Corporation needs to sell.

The agency has brought in BlackRock Financial Market Advisory to help manage the process while trying to keep those markets from taking a tumble. But investors have been holding back to avoid being burned in a fire sale.

The FDIC, receiver for the two failed banks, did find buyers for many of the banks’ assets. Flagstar Bank, a subsidiary of New York Community Bancorp, purchased $38 billion of assets: $25 billion in cash (including deposits, which are considered liabilities) and $13 billion in loans, paying $2.7 billion for the latter. The assets purchased didn’t include $60 billion in other assets or $4 billion in deposits Signature’s digital bank.

Raleigh, NC-based First Citizens Bank bought Silicon Valley Bridge Bank, including assets of $110 billion, deposits of $56 billion, and loans of $72 billion. But First Citizens didn’t want other assets from the holding company, Silicon Valley Bank.

Neither of the purchasers wanted the now-toxic bond portfolios of Signature ($27 billion) or SVB ($87 billion), according to the FDIC. The banks had heavily bought into MBS, CMO, and CMBS bonds at times they were getting a lot of large deposits from the crypto and tech startup industries. The banks put the money into bonds to generate profits at a time when yields were much lower than today but failed to hedge against the potential of an interest rate increase.

When rates went up, the value of the bonds dropped sharply, as yield and price move inversely to one another in those markets. The banks put the bonds into a held-to-maturity category, which meant they did not have to mark down the bonds as their values dropped. But that meant they were not liquid enough to sustain the number of withdrawals they’d see from concerned depositors. Once they started to sell the HTM bonds, the prices of them all got marked down and the banks were now insolvent.

The FDIC still holds the bonds and must sell them, but an influx of the assets at low prices to get them to move has already made investors uncertain.

“Anticipation of the FDIC’s sales have already hit prices, reported the Financial Times. It noted that the extra yield, or spread, demanded to hold securities with 2 and 2.5 per cent coupons has widened by between 0.18 and 0.27 percentage points more than the equivalent Treasuries over the past month, citing Bank of America analysts. By contrast, it continued, the spread for bonds with coupons of 6 or 6.5 per cent has narrowed by up to 0.19 percentage points.