The recent failure and bank run of Silicon Valley Bank (SVB) has unleashed a wave of doubt in many of the nation’s small and regional banks. Fortunately, the U.S. government stepped in to guarantee all of the customer deposits to prevent a run on other banks. But the trouble is not yet over as many are caught in the same predicament, including what happened in Europe with Credit Suisse.
Sadly, it is the regional banks that perform the valuable service of retail banking in less sophisticated towns and cities. The image of Jimmy Stewart as benevolent small-town banker George Bailey in the Frank Capra film It’s A Wonderful Life is not how films portray bankers these days. But for Main Street America, they are the bankers who matter.
Short of winning the Powerball, getting an inheritance, or making a killing in investments, most people can only buy their dream home if they take out a multi-year mortgage loan. With a fixed-interest, long-term mortgage, you are also protecting yourself from fluctuations in rent. For a lot of Americans, those mortgages come from regional banks.
In March 2023, a group of academics from top U.S. universities released a paper that analyzed the current status of U.S. banks with respect to their holdings of older U.S. treasury bonds prior to the Fed hikes that began in 2002. Their findings are worrisome.
According to this paper entitled “Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?” the US banking system’s market value of assets is $2 trillion lower than suggested by their book value if held to maturity. “Marked-to-market bank assets have declined by an average of 10% across all the banks, with the bottom 5th percentile experiencing a decline of 20%,” the paper stated.
Furthermore, it also said that even if only half of the uninsured depositors decide to withdraw, around 190 banks are at risk. They also said that this can affect around $300 billion of deposits. “If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the U.S. banking system to uninsured depositor runs,” the paper said.
Take note that the risk is only if the banks need to sell the bonds (and mortgage-backed securities) prior to maturity. This was what happened to SVB in March 2023 because it needed to sell assets to service its customer withdrawals. If the bonds reach full maturity, the risk goes away and they get back their entire amount. The problem is if depositors want their deposits back, the banks are forced to sell these assets.
If you recall, a balance sheet equation is assets = liabilities plus equities. A lot of the bonds that these regional banks bought are supposed to be part of their assets and these are slightly underwater now. Their liabilities are their deposits since they need to return that money to depositors. Finally, their equity (bank stock) is also taking a beating sector-wise in the markets.
Another worrying factor is that with an impending recession, many home buyers may find it hard to make monthly mortgage payments. No one wants to sign up for high mortgage interest rates at 7%, while the holders of pre-Fed hike mortgages (with low 3% interest rates) are paying only small amounts to the bank. The 3% rate is great for the previous home buyer but bad for the bank as it’s only a small incoming cash flow stream for them versus their higher cost of borrowing from other banks or from the Fed overnight window. Though those older 3% mortgages are probably statistically not going to default as much as their higher-interest mortgages.
Fewer mortgage takers means fewer home buyers, which means home prices will drop moving forward.
A recession will shrink budgets for food, utilities, and medicine, and cause families to possibly skip other bills or debts altogether. It’s a no-brainer. If your monthly payment for rent or your mortgage increases, you don’t want to default. But when a recession hits, that monthly mortgage payment that you could have easily made before might not be that affordable in the future if your salary or earnings gets cut. Especially at the new, higher rates.
Buying a house is part of the American dream, and can protect people against rent increases if they have a fixed-rate mortgage. With a fixed-rate mortgage, working families can plan the monthly payment against their other expenses. During the previous three decades of low inflation, affordable homeownership protected people against rent increases. Unfortunately, home ownership is under threat right now.
The regional banks are important because, like Jimmy Stewart in It’s A Wonderful Life, they are the ones facing the people in small towns and cities. Regional banking is personal banking. It’s not some nameless, faceless bank executive somewhere in a big city deciding on your loan using AI algorithms, but it’s someone in your community who will meet with you to interview you.
For the many who want to own their own homes and not rent at some point, a healthy regional banking system is necessary. Unfortunately, with the recent bank closures of Silvergate, Signature NY, and SVB, another wave of bank mergers and acquisitions might happen to ensure that the few big banks that are left are well-capitalized.
But if only the big national banks are left, they may also make it harder for many people to get the mortgages they need at the rate they want.
