Back in 2008, in the height of the financial meltdown, banks were scrambling to find money as customers were pulling out their deposit fearing bank insolvency. We witnessed giants such as Bear Stearns, Lehman Brothers, Washington Mutual, Wachovia, IndyMac and dozens of other financial firms fail due to this as well as over leveraging and liquidity issues. At the time, these banks were struggling to find funds to shore up financial shortcomings. While most think of the Fed as the lender of last resort, there is another Government Sponsored Enterprise (GSE) that has a significant impact on the wellbeing of banks in the United States: The Federal Home Loan Bank. Created in 1932, the FHLB, is a cooperative lending facility made up of 11 regional banks. In short, they are a privately held business which issues bonds to raise capital that is lent out (Advanced) to member banks. The banks secure these loans with mortgages they hold or other eligible types of collateral. As you can see on the chart below, as the markets were starting to fall apart in 2007, the dollar amount of advances taken by banks surged from $624 billion to over $1 trillion by Q3 of 2008. As the market was in freefall in 2008, FHLB stopped lending the banks money as credit ratings were being slashed, and collateral dried up. Remember, at the time, this was the greatest economic downturn since the Great Depression.

Fast forward to today. In the spring of 2023, the collapse of Silicon Valley Bank, Signature Bank and First Republic Bank shocked the banking industry and sent nearly all financial stocks tumbling. While we can point to multiple reasons why this happened, the gist if it is, bank reserves were drained. Customers panicked and demanded their money. These banks were forced to sell assets they held at a significant loss. While we witnessed unprecedented actions by the Federal Reserve, FDIC and the US Treasury Department to prevent a total collapse of the banking industry, the unsung hero may have been FHLB. From Q4 2021 to Q1 of 2023, the FHLB advanced member banks over $700 billion, peaking around $1.4 trillion worth of advances to member banks. Far more than the $150 billion by the Fed. For now, these monumental capital injections have stabilized the banking system, but a day of reckoning may be coming fast.

These advances to capital hungry banks are simply loans which must be paid back. The 3 major banks which failed in 2023 all relied heavily on the FHLB advances, and it still wasn’t enough. Banks, including Charles Schwab (SCHW), KeyBank, (KEY) PNC Bank (PNC), Northern Trust (NTRS) and many others have been pulling tens of billions of advances from the FHLB to make ends meet. Many hold a large percentage of total assets in the form of FHLB loans. If we look at the above chart again, that $1 trillion level is not only significantly high, its also ominous as it represented the financial woes back in 2008. Many in the media are calling for more bank failures in the coming months, and the recent downgrades of KeyCorp (KEY), Comerica (CMA), Associated Banc (ASB) and several others by S&P Global Ratings is not helping at all.

Long term, I’m bullish on banks, they are a necessary evil in the financial markets that will never go away. The key is to find the ones that will weather the storm and come out stronger while the weak ones fail. Back in March, I wrote an article detailing my willingness to own JPMorgan (JPM), Bank of America (BAC) and Charles Schwab. While I still stand by JPMorgan and Bank of America, due to the fact that they have almost zero exposure to FHLB loans, I’m bearish on Charles Schwab. Their high levels of FHLB exposure are enough to make any investor nervous. Couple that with the recent layoff announcement and office closure, it’s a clear sign that Schwab is struggling. While these types of cost cutting measures usually help businesses in the long run, share price may suffer in the short term. Schwab expects to achieve $500 million annual savings with these layoffs and closures but goes onto site that it will incur around $500 million in costs associated with these cuts. Zero sum game for the next year.

If you are a long-term investor in banking stocks, be sure to check and see how much money they are pulling from the FHLB. The higher that number, the greater the lifeline they are pulling to stay afloat.

Bear Stearns collapsed on March 16th, 2008. Six months later Lehman Brothers collapsed on September 15th, 2008. On March 10th, 2023 Silicon Valley Bank collapsed. If “Past performance” is any indication, could we see another big bank go under around September 15th 2023?

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