by Craig Love, on May 11, 2023
Kensington Market Insights - May 11
Market Insights is a weekly piece in which Kensington’s Portfolio Management team will share interesting and thought-provoking charts that we believe provide insight into markets and the current investment landscape.
Banking Back in Focus
In our March 16, 2023 Market Insights piece we discussed the possibility of contagion in the banking sector in the wake of the Silicon Valley Bank collapse. Since the time of that writing two additional banks have failed and the S&P Regional Bank Index is down approximately 35% year-to-date, pushing the market cap of these banks from over $300B in March to just over $100B today, a staggering 66% drop in just two months.
Source: True Insights, Investing.com
Perhaps more shocking is that we haven’t seen more failures during this period of value decline and deposit outflows. By contrast, during the Great Financial Crisis (GFC) the Federal Deposit Insurance Corporation (FDIC) closed 465 failed banks between 2008 to 2012. So far in 2023 there have been just three, although their combined assets are more than the GFC bank failure assets combined ($532B vs $526B). It begs the question, if these relatively larger banks have been unable to navigate the current landscape, why haven’t we seen more small banks collapse as well?
Source: ObservableHQ
On Stable Ground?
Despite stock prices dropping, we have seen some relief in the banking sector in recent weeks. Regional deposits rose $6.4 billion over the last week, and lending increased by $30.6 billion, according to Federal Reserve data. In the March FOMC meeting Federal Chair Powell said, “Conditions in that sector (banking) have broadly improved since early March” and that the banking system is “sound and resilient."
It can be argued whether that is the case or not, but even the Fed knows banks are not out of the woods just yet. In their latest Financial Stability Report released on Monday, they note that trouble in the commercial real estate sector is a possible risk to the U.S. financial system, stating, “Valuations in the commercial segment also remained near historical highs even though price declines have been widespread. In addition, fundamentals have weakened, particularly for the office segment.”
The report continues by saying, “The magnitude of a correction in property values could be sizable and therefore could lead to credit losses by holders of C.R.E. debt," noting that many of those holders are banks, and particularly smaller banks. In fact, regional banks are 4.5 times more exposed to commercial real estate loans than national banks, with several holding over 50% of their total loans in commercial real estate loans (as shown below).
Source: BBAE Research
Between a Rock and a Hard Place
With over $1 trillion of commercial real estate loans set to mature by 2025, we have to question how willing these banks will be to renew these loans given tightening lending standards, decreasing property values and higher prevailing interest rates. If they aren’t, it could mean a significant rise in defaults on their existing loan books, exacerbating current issues. As previously noted, credit is the lifeblood of our economy, and the ramifications of this potential credit crunch could reach far beyond just commercial real estate and regional banks.
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