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Is The Banking Crisis Over? Ask Google
I've spent a lot of time over the last four weeks discussing the psychological side of bank runs and financial contagion more generally.
The overarching point could scarcely be simpler: It's all a confidence game. In the US context, the issue for depositors, both insured and uninsured, is that government money market funds yield two and half, three or even four times what you can get on bank deposits, and such funds carry an implicit guarantee that's arguably stronger than an FDIC promise.
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Your last sentence is a great summation.
I am amazed at the amount of office space that is owned or leased by small banks that appears to be underutilized.
From about April, 2022 – February, 2023, my 89 year old dad and I drove around to the ten,or so, small/local banks where he and my mom had various CDs (all in amounts under the FDIC insurance limits). He then withdrew the deposits with an instruction to wire the cash to an online brokerage account that I set up for them (no major brokerage companies have physical offices where they live) in order to purchase UST/bills.
It seems like it would make sense to merge some of these small banks and get rid of excess office space.
A question and three (hopefully not too declarative) opinions:
Q. Aren’t FDIC-insured deposits up to 250k also backed by the “full faith and credit” of the U.S. government?
Poorly managed banks (SVB, Credit Suisse, etc.) must be allowed to fail (moral hazard, etc,).
Banks should be offering better rates to attract depoits at the expense of their margins (they’ve gotten away with low rates “murder” for years).
We will muddle through this and some day Jerome Powell will be accorded the same kind of kudos now reserved (almost exclusively) for Paul Volcker.
I’m expecting >50% of tier B and tier C commercial properties to be seized and/or liquidated in the next few years. The effect on mid-small sized bank balance sheets and earnings will likely lead to a crisis and mass consolidation in the industry.
+1
Banks are going to have to work with the commercial borrowers. Sure, the bank can certainly forclose and seize, but then what? Another Halloween Store?
I think I’m more sanguine than some about this. Here’s the back-of-envelope why.
Banks hold about 60% of CRE debt (the percentage I found is excluding multifamily, but let’s just assume the percentage is similar for MFD too).
In general, small banks have a CRE as a higher percent of total loans than large banks. There’s even a couple dozen smaller (but still publicly traded) banks where CRE loans are 200% or so of equity. Fig 16 at the link below.
https://insight.factset.com/assessing-cre-exposure-across-the-financial-sector
That all sounds alarming, but most CRE is not in peril. Correct me if I’m wrong, but it is office that is in existential distress. Retail, hotel, multifamily, medical, industrial, etc don’t seem to be facing life-threatening vacancy levels. Okay, shopping malls are dying, but that’s been going on for a decade. In general, non-office types of CRE will suffer to various degrees in a recession, but in a normally cyclical manner. I think the extinction-level meteor event is aimed quite specifically at office, especially class B/C properties.
Office is about 15% of total CRE by value.
https://www.reit.com/data-research/research/nareit-research/estimating-size-commercial-real-estate-market-us-2021
So, on average, think of around 15% of a typical bank’s CRE loans being in office, and suppose the value of those office properties declines by an average 40%. What loss will the bank take on those office CRE loans?
I don’t know what typical loan-to-value for office CRE lending is (some of you do), but the Fed’s 2022 “severe” stress test included a 40% decline in CRE values (all CRE, not just office), and banks’ stress-test losses on CRE loans averaged about 10%. Implying that LTV averages around 65%? See Fig 19 of the Factset link above.
So apply 10% loss to the 15% of CRE loans that are office, and you get something like 1.5% loss on the CRE loan book.
That sounds not bad enough to be fun. Let’s arbitrarily triple it and say 5% loss on the CRE loan book.
For the couple dozen most exposed banks, with CRE loans equal to 200% of equity, that would cut equity by 10% (5% of 200%).
There will always be banks that went way out on a limb, in CRE exposure, office exposure, LTV risk, concentration in the hardest-hit cities or in B/C properties. They will be toast. SIVB will not be the last bank to be closed down, dismembered, forcibly married off in pieces, before all this is over, we know that. But my sense is these will be small banks (look at the Fig 16 list, those are way down the market cap list of regionals).
In a nutshell, that’s why I’m now not as alarmed about CRE and banks as I was, say, two weeks ago.
What am I missing?