The ongoing tumult in the banking industry brought to light by the recent failures of Silicon Valley Bank and Signature Bank — the second and third largest bank failures in U.S. history, respectively — also threatens liquidity channels for the independent mortgage banks (IMBs).

Two banks that rank among the nation’s top warehouse lenders were recently singled out by Moody’s Investor Service for potential ratings downgrades due, in part, to their reliance on “confidence-sensitive uninsured deposits”; the material “unrealized losses” linked to now-devalued bonds held in their investment portfolios; and their “relatively lower level of capitalization.” 

The nation’s warehouse lenders are a lifeline of liquidity for the nonbank mortgage sector, providing IMBs with lines of credit and other financing that serve as key ingredients in the sausage-making of mortgage origination. The warehouse lenders identified in the recent Moody’s reports are Phoenix-based Western Alliance Bank($67.7 billion in total assets) and Dallas-based Comerica Bank ($85.4 billion in total assets) — which as of yearend 2022 ranked respectively as the seventh and 14^th largest warehouse lenders nationally based on market share, according to industry publication Inside Mortgage Finance.

Executives with both banks, however, contend their institutions are well-run and well-capitalized with diversified deposit bases as well as strong liquidity positions.

“In the mortgage space, warehouse lending is a very lucrative business for the banks, so in general they’ll want to keep warehousing lending, maybe over other types of lending,” said Brian Hale, founder and CEO of consulting firm Mortgage Advisory Partners. “The yields are good, they’re highly secured, highly collateralized, and they’re short-term loans.”

Even a solid lending line, however, isn’t bulletproofed against a systemic industry shock. That’s why Western Alliance, Comerica and several other banks have recently found themselves in Moody’s ratings spotlight. As important warehouse lenders, the fate of Western Alliance and Comerica, good or bad, also impacts the mortgage industry.

At the heart of the still-unfolding banking crisis is some $620.4 billion in unrealized losses, as of yearend 2022, linked to past bank investments —largely longer-term U.S. Treasuries and mortgage-backed securities (MBS). Those assets, many locked in at low coupons, have lost value in the wake of the rapid rise in interest rates over the past year. 

“Banks had large deposit growth during the acute period of [the pandemic] and didn’t have the ability to grow their loan portfolios as fast as they were growing their deposits,” said Nick Smith, founder and CEO of private-equity firm Rice Park Capital Management [RPCM]. “So, they funneled a lot of those excess deposits into fixed-rate, long-term bonds, like Treasuries and MBS, and they mismanaged their interest-rate risk.

“When the Fed [Federal Reserve] began their campaign to tamp down inflation using rate increases to accomplish that, the banks were caught in a position where they had these fixed-rate, long-term exposures that were moving in the opposite direction of rates going up, and as a result they had large unrealized losses [on those investments], so that’s the basic problem.”

That pool of looming investment losses, coupled with an exodus of deposits largely sparked by panic, played a major role in the failure of SVB. Prior to its collapse, the bank in early March sold some $21.4 billion in bonds from its investment portfolio to deal with the cash bleed and took a $1.8 billion loss on the sale, further cementing its course toward FDIC receivership.

“The failures of Silicon Valley Bank (SVB), Signature Bank and Silvergate Bank [which recently announced it would voluntarily liquidate], with assets collectively of close to $325 billion, have roiled the financial system,” said Mark Zandi, chief economist for Moody’s Analytics, in a recent commentary piece on the bank failures. “Once depositors lost faith in the viability of these institutions and began withdrawing funds, the banks quickly unraveled. 

“Bank runs are rare, but they happen at a dizzying pace when they do occur. These failures were especially surprising on the heels of a lengthy period of calm in the banking system. There were no bank failures last year or the year before.”

Hale adds, however, that there is already a massive deposit consolidation underway within the banking industry, with those deposits moving from community and regional banks toward mega-banks deemed too-big-to-fail. In fact, Bank of America reportedly raked in some $15 billion in new deposits in the wake of SVB’s recent collapse.

“Deposits have been coming out banks because banks were not offering the same deposit rates as depositors could get by just investing directly into the market,” said Smith of RPCM. “[In addition], depositors have been rushing to quality and taking their money out of weaker banks, or banks that they perceive to be weaker, and putting them into institutions that they view to be safer [such as the money-center banks].”

“So, that’s a fear-based drawdown. But I’m hopeful that the banks that have already been either rescued or failed, that they are the last of them, but I think there’s still concern around whether that issue is going to pop up with additional banks in the future.”

Hale stressed that every bank is unique, and that having a high volume of uninsured deposits is not alone a sign that those deposits are going to become a problem for a lender in terms of retention. Still, he and other industry experts, contend that absent concerted efforts to calm the waters, the risk of future bank runs remains real.

“No bank, in my opinion, could sustain a 50%, 60%,70%, 80% deposit loss,” Hale said. “You could never liquify fast enough. You need help. 

“And the minute you tell a customer, ‘No, you can’t have your money because we don’t have it to give you’ — Oh, Holy God, Katie bar the door!”

Credit contraction and warehouse lending

The threat to the integrity of the banking system if panic becomes widespread is one of the reasons central banks globally as well as U.S. banking regulators have acted quickly to inject liquidity into the system and, where necessary, even rallied private-sector players to assist troubled banks with loans and deposit infusions. 

Still, even if those efforts manage to prevent another bank failure this year, Zandi expects the banking crisis and the Federal Reserve’s inflation-fighting efforts will likely crimp lending in the future. The Fed’s Federal Open Market Committee on March 22 announced that it would raise the federal funds benchmark rate by another 25 basis points to a target range of 4.75% to 5%. The rate bump is likely to create added pressure on the already devalued legacy investment portfolios at many U.S. banks, Smith said.

“Despite optimism that fallout on the financial system from the bank failures will be contained, … the current turmoil in the system will likely lead to a tightening in underwriting standards and less credit availability,” Zandi said.

David Petrosinelli, a New York-based senior trader with InspereX, a tech-driven underwriter and distributor of securities that operates multiple trading desks around the country, agrees with Zandi’s analysis on that score.

“I think there is a there’s definitely a credit contraction,” he said. “It’s just a matter of to what degree. How much will these institutions [banks, including warehouse lines] retrench … is not readily apparent yet.”

Hale added that bank warehouse lines are already “getting shrunk” because mortgage origination volume is way down, pointing to a recent Mortgage Bankers Association report showing IMBs and banks lost more than $2,800 per mortgage loan originated in the fourth quarter of 2022.

“So, as mortgage companies are less profitable, the warehouse guys get nervous, and they start pulling the lines in a little bit,” Hale said.

Comerica

Moody’s in a report issued in mid-March said that despite efforts to bolster the banking sector, the high-rate climate will continue to create stress for banks, both in terms of profitability and capital, adding that action to date by regulators and other banking officials “is intended to protect the system against further funding [deposit] runs.”

“But [it] does not address banks’ vulnerability to excessive interest rate risk, which was the root cause of these banks’ distress,” the Moody’s “Sector Comment” report states. “We see the approach taken as credit positive for uninsured depositors; however, bondholders and equity holders will still need to absorb the economic losses some banks face related to higher interest rates as well as credit losses that are likely to rise with the coming turn in the economic cycle.”

In separate rating-action reports released on the same day as the Sector Comment report, Moody’s announced that it was placing the ratings of Western Alliance and Comerica, as well as four other banks, on “review for downgrade.”

In Comerica’s case, Moody’s said the rating action was the result of the bank’s “high reliance on more confidence-sensitive deposit funding,” the high level of unrealized losses in its securities portfolio,“ as well as a relatively lower level of capitalization.

“Comerica’s share of deposits which are above the Federal Deposit Insurance Corporation (FDIC)’s insurance threshold is material, making the bank’s funding profile more sensitive to rapid and large withdrawals from depositors,” the recent Moody’s ratings report states. “In addition, if it were to face higher-than-anticipated deposit outflows, the bank could need to sell assets, thus crystalizing unrealized losses on its AFS securities, which as of 31 December 2022 represented a sizeable 38.5% of its common equity tier 1 capital [or CET1, a key regulatory capital measure].”

Another report released last week by Moody’s shows that the share of Comerica’s deposits that are uninsured stood at 62.5% as of yearend 2022 while its CET1 stood at a healthy 10% — without accounting for the unrealized losses in its investment portfolio. When those losses are factored into its balance sheet, they do take a big bite out of the lender’s shareholder equity.

“Total shareholders’ equity decreased $2.7 billion to $5.2 billion at December 31, 2022, compared to $7.9 billion at December 31, 2021, primarily due to a $3.5 billion decrease in unrealized losses in the [bank’s] investment securities portfolio and, to a lesser extent, its cash flow hedge portfolio and defined benefit plan,” states Comerica’s 2022 Form 10K filing with the U.S. Securities and Exchange Commission.  

Nicole Idzi Hogan, a spokesperson for Comerica said the bank looks forward to “engaging with Moody’s during … to better understand their concerns around uninsured deposits.”

“We believe that any correlation between Comerica and the recently impacted banks in regard to deposits is an apples-to-oranges comparison,” she added. “Comerica has been in business for nearly 174 years with a track record of successfully navigating difficult business cycles. 

“Our proven, conservative business model includes commercial banking, retail, and wealth management; and thus, reflects strong industry and geographic diversification. Because of this, Comerica has a more diverse, stable and ‘sticky’ deposit base and we remain well capitalized and highly liquid.”

Western Alliance

Moody’s ratings-review report for Western Alliance Bank likewise dings the lender for its high reliance on uninsured deposits (58% as of yearend 2022); its “material unrealized losses” in its investment portfolio; and its “relatively low, though improving, level of capitalization [with its CET1 ratio at 9.3% as of yearend 2022, well above the 4.5% minimum].

“If it were to face higher-than-anticipated deposit outflows, Western Alliance could need to sell assets, thus crystalizing unrealized losses on its … securities, which as of December 2022 represented 21% of its common equity tier 1 capital (CET1) on a non-tax effected basis,” states the Moody’s report, dated March 13. “Such crystallization of losses, if it were to happen, could weigh on the bank’s profitability and capital. 

“…Western Alliance’s liquid assets represented 12% of tangible assets at December 2022, which is modest compared with most rated peers. … Western Alliance’s ability to generate capital internally may be limited by rising funding costs, and it could face difficulty raising fresh equity capital.”

In a press release issued on March 17, Western Alliance notes that its CET1 ratio would decline from 9.3% to 7.9% after adjusting for the $1.1 billion in unrealized losses in its investment portfolio. The bank also points out in the announcement that its deposit base is “highly diverse,” its level of insured deposits has jumped to 55% and that it has “immediately available liquidity of over $20 billion as of March 16.”

“We have a long history of financial stability and responsible, cautious risk management,” Kenneth Vecchione, president and CEO of Western Alliance Bank, states in the press release. 

Along with the Moody’s ratings report, the Kroll Bond Rating Agency (KBRA) last week placed a ratings watch on three credit-linked note securitization transactions issued by Western Alliance in 2021 and 2022.

“These watch placements occur amid a period of stress for [Western Alliance Bank], as well as other similarly-situated regional banks, including high levels of deposit withdrawals in the wake of the failure of Silicon Valley Bank and Signature Bank on March 10 and March 12, respectively,” the KBRA ratings report states. 

Officials with Western Alliance are in a quiet period prior to the bank’s first-quarter earnings release slated for next month and declined to comment.

InspireX’s Petrosinelli said the impact of unrealized investment losses on the Comerica and Western Alliance Bank’s balance sheets is “huge” and likely will require the banks to find additional ways to “shore up their capital positions.”

“I would think one or both of them will have to do something, and if it’s not raising capital of their own volition, then they may actually be encouraged [by regulators] to pair up with someone.

“… I’m sure those talks are going on right now, and I’m sure they’re being encouraged, maybe not so gently, to be thinking about that [a potential merger]. They may be partially bailed out of by the market [improving]. But I don’t know that that’s going to be the most likely outcome for them.”

One thing is certain, Petrosinelli added, the upcoming first-quarter earnings reports for the banking industry should offer a lot more clarity about the status of these and other lenders.

“…We will know more in the next couple of months,” he said. “There is going to be a lot more that comes out on this [during the upcoming earnings reports Q1] and a lot more that we didn’t know beyond the headlines. The devil is in the details.”

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