H Reddit Mentions | ChartExchange

IntraFi... Is anyone else looking into this? Any bankers out there seeing any large redemptions from the network with the outflow of large depositors?
Is IntraFi a true house of cards? As one deposit is pulled, how many more connected deposits follow it thanks to Section 202?
In 2002, the Promontory Interfinancial Network (PIN) was created to help large depositors receive higher FDIC limit protection (millions of dollars worth) through a system called the Certificate of Deposit Account Registry Services or CDARS for short. This system became relatively popular and wasn’t a massive strain on liquidity or redemptions as it could ladder CDs that were easier to time and not “on-demand.” These deposits were somewhat segregated and considered brokered or reciprocal deposits, meaning the receiving end bank was showing the deposit as not theirs.
To help illustrate, imagine a high depositor goes to their bank, let’s call it Fancy Bank, with $1 million and requests additional FDIC protection. At that time, FDIC limits were $100,000. So, Fancy Bank obliges and takes your deposit. They then turn to Mom Pop Bank, Community Credit, and other small banks under much less regulation restraints to place $100,000 at each for FDIC protection. It’s in the form of varying CDs so these banks know when assets may leave to better plan. Additionally, it’s recorded as a reciprocal deposit, meaning the small bank does not own that deposit; another bank does. In our example, Fancy Bank.
Everyone wins. Fancy Bank has a happy, calm depositor. Small banks are happy as they get new deposits. Growth continues. In 2006, the U.S. banking system had roughly **$67 billion** in reciprocal deposits, most likely leveraging this network. But, then came the financial crisis, which lead depositors to demand more liquidity. So, they launched the Insured Cash Sweep (ICS) service in 2009, granting depositors in their network significantly faster access to their deposits. However, it’s important to point out that deposits weren’t “on-demand” though the financial crisis, so the network avoided any true liquidity constraints. Beyond the 2008 financial crisis, banking deposits continued to grow, so liquidity never became an issue. By 2020, it was estimated that there were roughly **$353 billion** in reciprocal deposits, according to the FDIC report.
Enter… the pandemic. Let’s ignore all the nuances that occurred and focus solely on bank deposits. Deposits surged from $13.2 trillion in January 2020 to $18.15 trillion at its peak in April 2022. Again, surging liquidity. Deposits, which fuel bank growth, ballooned. To give a non-financial example, you can think of Peloton. During the pandemic, they believed it was the new norm of limitless demand for overpriced equipment, charging into the next frontier of fitness. With the benefit of hindsight, that didn’t happen. They over-extended and have barely staved off bankruptcy, watching their stock dive from over $160 a share to now under $10.
Many banks surely acted the same, not limited by regulations since deposits were surging. But, the FDIC report from December 2022, showed a much gloomier picture for the sea of liquidity banks once experienced, with deposits declining and loans surging. Deposits leaving the system are primarily non-FDIC insured deposits, which seem to be flocking toward higher-yielding money market funds and treasury bonds. And again, this flight started in the middle of 2022. Bank runs are stealing the headlines in 2023, but it seems most are missing the underlying issue. According to the [FDIC’s report](https://www.fdic.gov/analysis/quarterly-banking-profile/fdic-quarterly/2023-vol17-1/fdic-v17n1-4q2022.pdf), loans jumped $1 trillion while non-FDIC insured deposits fell $226 billion. For 2023, this has accelerated, with nearly $250B already leaving the system within less than three months. This is what the Fed wants though. They want to decrease cash. Depositors are turning over their dollars for bonds and money market funds. And why should anyone believe this is ending soon?
Take this information now with the context of Silicon Valley and Signature bank failures. Loans are illiquid. They aren’t currently helped by the fed’s liquidity boost to lending on par value of their security holdings to help give banks temporary cash. Temporary being the key word as these are loans, not a true injection of liquidity. Money is leaving the system. It is simply more observable at the banks that cater to this kind of depositor, like First Republic. With the Fed continuing to excessively hike rates, it will continue to widen this gap. Bank deposits will continue to leave until rates normalize in line with what banks can compete with, which would take year or more for loans to mature and banks to better align their assets and liabilities.
This brings us back to the Promontory Interfinancial Network, or IntraFi as they now call it. Let’s jump back to our Fancy Bank example. The large depositor now decides, “hey, Fancy Bank, I can get 4.6% in a money market fund right now. That’s cray. I’ll just take my deposit, thank you.” Fancy Bank returns to their small banks and says, “Give me my depositor's money. It’s not an issue, as you’re reporting these as reciprocal deposits, which everyone can readily see.” But, the Community Credit CEO stands up and says, “Actually…”
In 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) was signed. Small banks were excited about “Section 202,” which allowed for “well capitalized” banks to remove this silly reciprocal language and count them as core deposits, relieving additional scrutiny from regulators. Again, the system had been around since 2002 and had never experienced declining banking deposits. Therefore, net-deposits into the network continued to outpace any net-redemptions. And then 2022 inconveniently happened. According to IntraFi, nearly 3/4ths of their network members have less than $1 billion in assets and 95% under $10 billion. These deposits are heavily relied on by their members.
In a normal environment, I don’t blame them not being concerned with it being at over 20% of liabilities. It seems almost impossible for a system as a whole to see that kind of redemption or stress. And at that time, IntraFi had seen nothing but an increase in assets, which are now estimated to be over **$500 billion, potentially close to $1 trillion**. As of March 15, 2023, [referencing the recent H.8 release](https://www.federalreserve.gov/releases/h8/current/), total US bank deposits were roughly $17.5 trillion. Removing large commercial banks there are roughly $6.8 trillion in deposits. So IntraFi is making up somewhere between 7% - 15%. We could probably assume is on the higher end, maybe even closer to 20% for all the smaller banks that want to stay under the threshold. We can’t have reliable numbers as Section 202 removed the ability to see these deposits.
But, let’s look at what we can see. March 15, 2023 showed an unusual drop in deposits for small commercial banks after what had been a relatively stable year before, falling from $5.521T in deposits in Feb 2022 to $5.468 T on March 15, 2023. Loans in that period went from $3.9T to $4.5T over that same period. That’s roughly a 15% buffer between illiquid loans and deposits, potentially the size of IntraFi deposits. The concern being, if IntraFi begins being a liquidity drain on the system, in addition to other depositors leaving for alternatives. In any other scenario, 15% looks wildly safe. But, what happens when IntraFi pulls large swaths of deposits from the small members, which could start seeing other deposit issues. Those small institutions will have the highest rate of loans to deposits, making them insolvent.
The FDIC has blown its coffers on Silicon Valley Bank and Signature Bank. If First Republic and others fall, what funds will be left? The regulators are selling assets significantly below their fair value, evident by First Citizens stock surge on the announcement. But, what happens when people learn the FDIC has no funds. As they approach their bank with the latest ABC news headline, they’re bank said, “your deposits are safe. They’re FDIC insured!” … “But, the FDIC doesn’t have any money…” You get the idea.
All this being said, many banks have an extraordinary amount of liquidity and will be fine. They’ll benefit from this chaos if it occurs, as they’ll wind up substantially larger than just months before. First Citizens doubled in size overnight. From the hundred or so banks I’ve had to review over the last few weeks, I would say probably 90% are fine. But, can the system handle 10% chaos, especially when looking at the smaller banks? Sure, the FDIC can stomp in and make demands to a massive bank with $100 B in deposits. What is it going to do with 500 community bank failures all with $1 B deposits? The Fed can make loans liquid, at least yet.
Ultimately, the US banking system is seeing a liquidity crunch unlike what it’s ever seen before, except when compared to maybe 1929, which lead to the creation of the FDIC. At that time, the Fed was focused on saving the dollar at any cost. The lack of FDIC’s existence could probably be credited for the total ruin of the economy, as savings were gone and banks and savers had to rebuild. But, ironically, this liquidity crunch is now driven by the larger non-FDIC insured deposits. Now, depositors are paying closer attention to their bank’s balance sheet, which is good thing. But this transfer of money isn’t from fear of banking collapse. It’s happening due to higher yields outside of the system, and it seems to just be the beginning. As the Fed keeps hiking rates, banks will be unable to compete with treasuries and money market funds. If banks face withdrawals, many may be forced into realizing some large losses held in their securities. Other banks won’t have enough securities to sell and be insolvent.
I do not doubt the Fed will come in with another liquidity bazooka and maybe even potentially dropping rates, trying to reset the system. But, will we see the explosion of inflation again? It seems we’ll be caught in an endless boom and bust cycle, spurred by the Fed, which was initially created to try and stop or ease market cycles, eliminating the boom and bust cycle. Again, more irony.
So, as the high depositors continue moving funds, it only seems inevitable to eventually put stress on the IntraFi network, most likely for the first time in its history. That would in turn put stress on community banks, which may then see their own stresses from their truly non-reciprocal deposits that may seek shelter in the majors like J.P. Morgan and Bank of America, if remaining in the banking system. For smaller deposits, this continues to seem to be the case, as the majority of the recent drop in small bank deposits seems to have shifted to the top fifteen. While is pushes consolidation, it does not leave the system, so these aren’t of huge concern. On top of these liquidity issues, commercial real estate will be a huge headwind for banks that are heavily concentrated in assets that have now dropped severely in value from either occupancy issues or loans that were made too favorably in the first place.
However, the large depositors that are leaving the system have to be the ones most connected to the IntraFi system, which would begin to see massive redemptions for the first time in its history. How many loans depend on the initial deposit as Section 202 allowed it to be a core deposit of members? Time will tell, but it seems to be the cliche card at the bottom of the house that could be set to fall. I hope it’s not.
The trade? Long treasury bonds. Short banks with high loan to deposit ratios with limited securities holding relative to uninsured deposits and high commercial real estate or constructoin loan mix. Bank OZK (+50% non-FDIC, +95% loan/deposits, \~40% construction, +23% commercial mortgage) sticks out as a potential *if* deposits start slipping.
Cheers