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.
A government money market fund is, in one way or another, backed by the “full faith and credit” pledge. Notwithstanding the recurring debt ceiling charade in Washington, that pledge is sacrosanct, and there’s no “upper limit” on it — if it’s not honored, or if any breach isn’t understood to be a symbolic political protest to be rectified immediately, the problems will pile up so quickly that all but the most irrational of lawmakers will relent.
It’s safe to say that more people (and firms) appreciate all of the above in the wake of SVB’s failure, and are prepared to act accordingly. For evidence to support that contention, look no further than the accelerated bank deposit flight and simultaneous influx of cash into government money market funds.
There are, of course, measures US officials can take to shore up bank confidence and currently, the Fed is attempting to do so while simultaneously fighting inflation. The plan can be summarized as follows. Allow banks to pledge high quality collateral at par for Fed loans to meet their liquidity needs, and let them (banks) decide whether they want to sacrifice margin to attract new deposits. In a situation where the economy was already in a recession, that might not be optimal. But currently, the read-through of higher deposit rates for credit creation (i.e., less of it or on stricter terms) is desirable to the extent it helps bring down inflation. As long as the Fed can keep banks solvent (with emergency liquidity facilities), the situation is “stable.”
Ideally, though, depositors of all shapes and sizes will regain confidence in small and midsize banks. As TD’s Gennadiy Goldberg and Priya Misra wrote, the current conjuncture isn’t especially ideal. “Banks can continue to address their liquidity problem for some time, but borrowing from both the FHLBs and Fed facilities tends to be quite expensive, creating downward pressure on bank net interest margins,” they said. “With banks buying a significant amount of Treasurys and MBS during 2020 and 2021 at extremely low rates, continuing to finance the securities at rates near 5% will create significant earnings drags, exacerbate the capital concerns and could impede lending activity.”
So, again, what’s needed is confidence. And on that score, the good news is that people aren’t Googling as much. “US funding markets continue to function smoothly, though borrowing costs remain a bit elevated [and] encouragingly, public concern about the banking turmoil has also faded, reducing the risk of further deposit outflows,” Goldman’s David Mericle, James Yaro and Vinay Viswanathan wrote, citing search activity.
The figures above were produced by Goldman’s “Data Works” department (I have no idea) and suggest that Google searches “about both regional banks perceived to be under stress and withdrawing deposits have fallen back to roughly normal levels.”
That might seem trivial, but coming full circle, it’s actually all that matters — and in a very real sense. This is nothing but a confidence game, and if you’re a small, vulnerable bank, just about the most terrifying prospect imaginable is a situation where your depositors are all Googling “bank withdrawals” at the same time.
Goldman’s assessment (which spanned a half-dozen pages) was generally constructive, but it did come with a word of caution or, perhaps it’s more apt to call it a recitation of risk factors.
“Regional bank equity prices have remained depressed since the start of the banking stress, highlighting ongoing investor concerns that past deposit losses, higher deposit betas, a higher cost of capital, the possibility of tighter regulation ahead and an inverted yield curve will prove challenging,” Mericle remarked.
Other than those headwinds, though, all’s well.
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?