While the sudden collapse and seizure of Silicon Valley Bank (SIVBQ) by the FDIC on March 10 caused a loss of confidence in the banking system, the banking crisis continues to simmer in the wake of the recent forced sale of First Republic BankFRC (FRCB) to JPMorgan (JPM). Other banks remain in the crosshairs. For example, PacWest Bancorp (PACW) disclosed that deposits fell by 9.5% for the week ending May 5. PacWest’s stock is down over 80% year-to-date and lost 21% last week alone. The challenge of analyzing bank safety is that a severe loss of confidence can actually cause an otherwise functioning financial institution to come under duress. Weekly data released by the Federal Reserve indicate that stresses remain in the banking system even if we are likely past the worst of the crisis. Aside from the market pricing data and government money market mutual funds asset flows, the bank data come from the Federal Reserve’s weekly reports, released Thursday and Friday.
In addition to the pressure on the regional banks, the FDIC announced a plan to have a special assessment on banks to cover the $15.8 billion in losses from the Silicon Valley and Signature BankSBNY failures. If enacted as proposed, it would dent large bank earnings by 2-6% in 2024 and 2025, according to an analysis by JPMorgan. Not surprisingly, the bank indexes underperformed the S&P 500 by a wide margin last week.
U.S. Bank Stock & CDS Prices
Glenview Trust, Bloomberg
The KBW Regional Bank index is down over 32% year-to-date. As measured by the KBW Bank index, larger bank stocks declined 28% year-to-date.
Bank Stock Performance
Glenview Trust, Bloomberg
Credit default swap (CDS) prices are less well-known but available in real-time. In simple terms, CDS functions as an insurance policy that investors can purchase that pays off in the event of a borrower’s default. A higher price of a CDS reflects a more significant probability of default of the borrower. CDS prices for four of the U.S.’s global systemically important banks (G-SIBs) are near their lowest levels since this crisis began. Generally, the view is that the mega banks are safe and might benefit from the deposit flight from and worries about the smaller banks.
Mega Bank CDS Prices
Glenview Trust, Bloomberg
A straightforward way to measure the stress in the U.S. banking system is the magnitude of bank support provided by the Federal Reserve via various facilities. The most common is the discount window, which banks generally avoid, but the facility can provide emergency liquidity. In addition, following the collapse of Silicon Valley Bank, the Federal Reserve announced a new facility to help banks meet withdrawal requests from depositors and restore confidence. The Bank Term Funding Program (BTFP) allows banks to borrow up the face value of any government bonds held in the bank’s portfolio at a very reasonable rate. The Paycheck Protection Program (PPP) facility was created in 2020 to provide support during the pandemic. Other credit is the support of the bridge banks, operated by the Federal Deposit Insurance Corporation (FDIC) until they can be sold or liquidated.
Total Federal Reserve Bank Support Facilities
Glenview Trust, Bloomberg
With the seizure of Silicon Valley Bank and Signature Bank, discount window and bridge bank credit usage soared. The recent significant shift from discount window borrowing to the bridge bank is almost certainly related to the failure of First Republic. Last week, discount window and bank term funding program (BTFP) usage rose, which indicates some added pressure. The credit used by the bridge banks declined as the FDIC made some headway in winding down the failed banks. Overall, the decrease in Fed bank lending across its facilities for two weeks in a row is encouraging. Still, the uptick in the discount window and BTFP usage, along with the news from PacWest, raises the specter of more possible bank failures.
Fed Bank Support Facilities
Glenview Trust, Bloomberg
On a more positive note, the banking system saw net deposit inflows across large and small banks for the first time in a few weeks.
U.S. Bank Deposits
Glenview Trust, Bloomberg
Notably, the 25 largest banks, which include many midsize regional banks, have lost about 1.3% of their deposit base since the failure of Silicon Valley Bank, while the smaller banks lost 4.4%.
U.S. Bank Deposits By Bank Type
Glenview Trust, Bloomberg
Government money market funds saw inflows again last week but at a slower pace. The money market data is provided with less lag than the Federal Reserve’s bank data, which could signal less systematic concern related to PacWest. Cash has been flowing into government money market funds, which confirmed the pressure on deposits to leave the banking system. Notably, the pace of inflows into government money market funds has moderated significantly since the apex of the banking crisis. This movement, also known as “cash sorting,” reflects savers reaching for higher yields while avoiding the credit risk at banks. Cash sorting started before the crisis began but seems likely to continue to some degree while short-term U.S. Treasury yields exceed the interest rates banks pay depositors.
Government Money Market Fund Assets
Glenview Trust, Bloomberg
Banks have continued to make loans despite the crisis, and total bank lending grew last week, driven primarily by small banks. Loan growth should be expected to slow if banks are forced to hoard extra liquidity to bolster their defenses against possible additional deposit flight and increased loan losses.
U.S. Bank Loans
Glenview Trust, Bloomberg
The first signs of a potential credit crunch in commercial real estate (CRE) lending appeared some weeks ago when lending to that segment fell the most on record. However, CRE lending from small banks has been higher for five straight weeks. Smaller banks are the leading provider of commercial real estate loans, so that sector could face less credit available if the deposit drain continues at those banks.
While the better news on inflation was a positive for the banks and stocks overall, the negative bank industry news and the contentious debt ceiling negotiations dominated last week. The 10-year Treasury yield is below 3.5% after being above 4% earlier in the year. This change is vital because many banks have suffered losses in their bond portfolios as yields rose, so a decline in interest rates helps boost the bond portfolio values. In addition, most believe the Federal Reserve will stop increasing short-term interest rates and may even reduce them later in the year if inflation continues to improve and the economy weakens. Lower short-term interest rates could decrease the cash sorting pressure.
April consumer inflation (CPI) was better than expected and moderated to 4.9% year-over-year. While this is still well above the Federal Reserve’s 2% target, it continues to move in the right direction, and there are signs that the progress should continue.
Year-Over-Year Inflation Measures
Glenview Trust, Bloomberg
The sticky inflation measure improved slightly to 6.5% but remained uncomfortably elevated. The better news is hidden under the surface because much of this elevated sticky inflation is related to housing and services pricing. The rent component in the CPI calculation uses a methodology that causes it to lag the real-time data. Actual rent data indicates that the CPI rent should begin to move lower.
Actual Rent Versus CPI Shelter Component
Glenview Trust, Bloomberg
Services pricing is closely related to wages. Initial claims for unemployment benefits have increased, signaling some softening in the labor market, which should reduce the upward pressure on wages. Unfortunately, if the job market weakens too much, it would likely lead to a recession and rising bank loan losses.
Initial Jobless Claims
Glenview Trust, Bloomberg
While the banks saw deposit inflows and decreased usage of the Federal Reserve’s bank support facilities, the banking crisis continues to simmer. The systemic panic phase of the situation appears to be over, but some banks perceived to be in a weakened state remain at elevated risk of failure. These troubled banks usually share the characteristics of a large proportion of uninsured deposits and significant losses within their bond portfolios. In addition, significant expected losses within a bank’s loan portfolio are an additional red flag. While the volume of bank loans has seen no appreciable decline after the initial shock, a higher probability of a U.S. recession in 2023 will be the intermediate-term result of the banking problems if credit is constricted. The improvement in inflation, which should allow the Federal Reserve to pause its rate hikes, should be a positive for the banks unless the economy falls into recession.
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Disclosure: Glenview Trust holds JP Morgan (JPM), Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), and Goldman Sachs (GS) within its recommended investment strategies.
