It’s been a fun and eye-opening experience watching the Web3 space continue to be built-out as more and more brands are actively jumping in (despite some agencies and politicians actively trying to stop portions of it) but I haven’t forgot about the ongoing challenges in the banking sector.
Here is a quick summary of some of the events of the last 4 weeks:
- Banks Silvergate, SVB and Signature (and Credit Suisse in Europe) are all gone. The US bank failures were largely the result of 3 primary actors:
VCs and other advisors actively telling their portfolio companies to get their cash out (in the SVB case), helping contribute to a run-on-the-bank
Federal Reserve raising rates at the fastest rate in recent history (0% to 4.75-5%) in the past 12 months
Bank managements chasing yield by putting a large amount of customer deposits in long-duration securities (i.e. 10-year+ MBS and Treasuries which quickly declined in (present) value given the rate increases described above.
But were there also some other contributing factors?...
Inflows to MMFs (money market funds) prior to March 10 —
Given the very low interest rates we were all getting in our checking/savings accounts, it makes a lot of sense that customers were actively withdrawing their cash and moving into money market funds yielding as much as 4% as it was recently reported a whopping $506B moved into MMFs in Q1 2023. Granted, a decent amount continued to move over after March 10 but a substantial amount moved out of banks and into MMFs before March 10 causing some reserve ratios and bank balance sheets to look shaky.
Continued outflows of cash from tech startup companies —
As many of us are aware, many tech startups rely on investments from VCs as they are rapidly scaling their business in hopes to capture market share and grow customers and revenue at very impressive growth rates. But this requires ongoing ‘cash burn’ and significant losses from each year (despite the ongoing success of Roblox, they reported a loss of about -$924M in 2022).
So, with customers moving cash from low-interest bearing accounts to MMFs and continued cash withdrawals from startups (primarily an issue for SVB), these were additional factors in the recent bank failures.
The Fed/FDIC then came in to guarantee customer deposits and restore confidence. But was this the end of the troubles for banks? Unfortunately, many mid-size/regional banks rely heavily on commercial loans to companies across many industries. And some banks have fairly large exposure to commercial real estate loans. But why might this be an issue?
Pending challenges with CRE (tightening credit and default risk) —
While some companies are starting their return-to-office policies, many companies have not. Some of the media have reported office vacancy rates of 30-40% while Forbes recently reported vacancy rates of 50%+. Without some of the former tenants, the property owners may not be receiving enough rental/lease income to make payments on their loans. And given that many of the banks we have been talking about have a significant amount of these CRE loans, banks will need to foreclose on these properties if defaults occur. We are already starting to see some significant defaults over the past couple of months including a big default by Blackstone in February and a $1.7B default by a PIMCO-owned office landlord in March.
And it’s not just office space either. Several retail locations are still having some issues finding new tenants. As we all know, many businesses struggled to survive during Covid and unfortunately many were forced to close down. This has led to many retail locations with a large number of vacancies. To get an idea of how my own neighborhood was affected, I took a walk in a popular area and was a little surprised to see many locations without tenants. Similar to office property owners, the owners of these retail buildings may have trouble making loan payments as well.
If banks need to foreclose on office or retail properties, they will own the buildings but may have difficulty finding a buyer if they need liquidity. Some analysts are projecting significant declines in CRE property values in the next 12-18 months. Remember that banks can borrow cash from the new FDIC/Fed program created on March 12, but they can only put up MBS and Treasuries as collateral. They can’t put up office buildings or retail properties to get access to cash from this program. If this becomes a more widespread problem the Fed may have to change some of the terms of the program to help with bank liquidity needs.
To be clear, I don’t think a lot of banks are going to have major problems with these issues. I haven’t looked closely at too many bank balance sheets but so far, I’ve only seen a handful of regional banks that have a fairly high exposure to CRE loans which may be at risk. And perhaps, they will get assistance from the Fed or the other big banks who will look for an opportunity to acquire assets and customers at a fairly low price (i.e. like the UBS acquisition of Credit Suisse).
I don’t mean to add any excessive fear of a full blown financial crisis like 2008. I don’t think that is likely to happen at this point. But this is a very fluid situation and I do believe the situation is not looking good for some of the players. With these concerns growing, banks will continue to tighten credit standards and this reduction in credit will be tough for unprofitable tech companies and other companies also in need of additional credit (VC-funding is also drying up compared to previous years). Property developers may be unable to get loans or have difficulty getting their existing loans refinanced. And these issues may have a trickle-down affect into many other areas of the economy.
The likely slowdown/recession is probably why the market seems to think that the Fed will have to lower interest rates sometime later this year despite persistent inflation. And with lower interest rates, some investors are continuing to buy up risk assets like crypto (BTC up 70% in Q1) and stocks. But if we are headed for a deeper economic slowdown, these formerly fast-growing companies (in tech and other industries) may not deserve the earnings multiples they have now.
Once again, these are just my own personal opinions. None of this is financial advice and just some thoughts based on my own observations and experience. I’d love to hear from any of you on how you’re thinking through the current financial and economic environment. Thanks again for reading and hope you’re all hoping for the best but doing a little preparation for the worst. Remember that even in a worst-case scenario that it would only be temporary. Many of us have seen much bigger downturns in the economy and markets, and any downturn would likely be a good opportunity in the longer run.
#Markets #Economy #Recession #CommercialRealEstate
Your article was spot on! Read an article this morning from the “Daily Money “(from USA Today) about the same thing!
As an aside, have you been following the news about Schwab?
Any concerns there?