“This is a case of bank regulation finding itself fighting the last war” - anonymous PM

**If you enjoy this newsletter - do us a favor & forward it to your friends or colleagues**

Notes:
(1) *Update*: Depositors are bailed out; Signature Bank is also closed (Sunday night); Bank Term Funding Program Term Sheet; graphic (Table 1) below is updated -

(2) Quick note today - at the start of my career, I (Matt) was an Asset-Backed Securities analyst. What happened with Silicon Valley Bank (SIVB) was surprising - enough so that I spent my Sunday digging up why SIVB owned Agency Mortgage-Backed Securities (MBS). In doing so, I discovered that a few other banks also have (or had at year-end ‘22) significant MBS positions.

(3) We will continue to be writing sporadically, for the indefinite future; if the note is too “hot”, it will only go out via email (will not be available on the site)

BANKS & MORTAGE-BACKED SECURITIES .

Among a few other securities (such as Treasuries), Agency MBS have a very favorable Risk-Weighted Assets (RWA) treatment.

Accordingly, banks bought Agency MBS:

The Great Financial Crisis (GFC), was caused by a credit crisis. The resulting regulation - therefore - focused on applying risk-weights to credit risk.

When considering credit risk, it is reasonable to apply attractive risk-weights to Agency MBS.

However, Agency MBS have an additional risk that Treasuries don’t have…

**Prepayment Risk**

When interest rates were low, borrowers were prepaying mortgages at a high rate (e.g. ~40%).

As rates have risen, those borrowers have prepaid mortgages at a lower rate (e.g. ~5%).

The effect on senior, triple-A rated Residential Mortgaged-Backed Securities (RMBS) is that the Weighted Average Life (WAL) on some bonds have extended out from initial expectations of 2 years to *11 years*.

Now consider that RMBS is a fixed rate asset class. When interest rates rise, fixed rate bond prices drop.

And, the longer the duration of the bond is, the further the price drops.

Long story short: mortgage prepays stopped, bond duration widened, and the banks that were focused on optimizing RWAs were now stuck holding credit-good bonds that have declined by ~20% in value.

Banks & bank regulators have found themselves successfully executing a defense against credit risk, only to get Blitzkrieged by a duration attack from borrowers ceasing mortgage prepayments.

And a surprised Silicon Valley Bank collapsed like the French to the Panzers -

OTHER NEWS / NOTES.

• For more on SIVB, check out Matt Levine’s Money Stuff

• Table 1 (above) lists a summary of select banks & their RMBS exposures

• There are a number of other factors that will affect these banks, such as deposit concentration (consumer vs corporate), hedging, AFS/HTM designations, other security holdings (such as CMBS, which may have credit risk), too-big-to-fail, etc.

• We are not short any of these names

Hope y’all have a fun week -