'We stay in our lane'
Not all regional banks are caught up in the turmoil.
So said the president of a local regional bank in York, where I spoke before several groups of bankers and small business leaders this week. Like other regionals I have presented for recently, they are having to assure customers as to the strength of their balance sheets before they introduce me. Banking’s turmoil isn’t over. This morning’s troubles at Deutsche Bank affirmed as much. It’s not your typical crisis rooted in lending woes that, as in 2008 and 1990, can take years to work out. This one features deposit beta and unrealized losses and is playing out much more quickly. Empirical Research says banks in the deepest trouble grew deposits three times faster than the industry in recent years, and lots of depositors want out. So far, it’s not a contagious credit event. But the dynamics are similar and are threatening weaker banks, so a macroeconomic shock cannot be ruled out. In the year since the Fed’s most dramatic tightening cycle in its history, J.P. Morgan estimates the most vulnerable U.S. banks lost $1 trillion of deposits—half of that before this month. Stingy bank deposit rates drove some customers away, while large depositors sought safer homes for their uninsured deposits (almost $7 trillion of U.S. bank deposits are uninsured). In dueling appearances Wednesday, Powell at his post-FOMC press conference and Treasury Secretary Yellen before Congress sent conflicting messages on whether all bank deposits will now be backed by the government. But both emphasized the U.S. banking system is sound.
Less-regulated regional and smaller banks with assets under $250 billion have been the lenders of choice in recent years. Empirical says their gross loan originations in commercial real estate (CRE) topped $850 billion last year, more than double the level of a decade earlier, and that two dozen of the largest institutions in this space represented 17.5% of the banking industry’s entire loan book in 2019 and 40% of all loan growth thereafter. The recent panic has many banks working to hold on to deposits and shore up balance sheets. Emergency borrowing at the Fed’s two backstop facilities totaled $164 billion this week, matching last week’s rush. This is, after all, the task for the lender of last resort. This and other crisis-related credit extensions have reversed five months’ worth of Fed efforts to shrink its balance sheet. As Yardeni Group reminds us, in previous financial crises, the amount outstanding in the liquidity facilities fell sharply once the crisis abated. Even before Silicon Valley Bank, banks were tightening lending standards. Now, with the Fed signaling further rate hikes and Powell saying rate cuts are off the table this year (the market at the moment is pricing four to six cuts this year!), they’re certain to apply the screws to lending activity. Pressured to raise deposit rates to retain/lure customers when the yield curve is as inverted as it’s been in 40+ years, banks’ net interest margins, the lifeblood of their business, are at risk. A CRE market clobbered by work-from-home and online shopping only adds to banking’s concerns. Growth rates of commercial mortgage books of some regionals have been eye-popping, Empirical says. For a few, they represent more than a quarter of their loan portfolios.
Shrinking credit availability—credit issuance already has stalled in the corporate bond market—and a more cautious consumer (nearly 75% of those surveyed by Evercore ISI plan to reduce spending on non-essentials) raise recession odds. Maybe not right away—there’s a lot of momentum in the economy (see below). But with the Fed projecting unemployment to rise a full percentage point from January through December, late fall/early 2024 aren’t looking so good. Never has unemployment risen that much without a recession, and never has a bear market bottomed before a recession begins. Never, that’s a long time. Humility, and patience, are advised. In York, my upbeat audience was dismissive of the banking worries. A CRE executive explained, “Ours is not an office market, but a retail and industrial one. Business is booming. You can’t find industrial space!” Business is also booming for a robotic manufacturer whose chairman has been in the business for almost 50 years. “In the last eight years, our programmable labor-force replacement robots are the fastest growing part of our company.” They serve government and manufacturing entities. “Regional banks are here to stay. They are your partner, they understand your business, they fund you as you grow.” And at least around these parts, they stay in their lanes.
- Will housing’s early spring last? New home sales rose a third straight month in February and existing home sales jumped, ending a 12-month string of declines. Mortgage applications for purchases also were up a third straight week as 30-year fixed mortgage rates fell to under 6.5%, a 5-week low. Both single-family and multifamily permits were revised upward to a 5-month high, while the median price of existing homes dipped and is now 4% below last May’s peak.
- PMIs show no recession S&P Global’s initial read on U.S. March manufacturing and services surprised, with the manufacturing component inching toward breakeven and services surging to an 11-month high. Pricing metrics reflected cooling inflation, while the overall readings were consistent with improvements in the EU and U.K. Also, core February durable goods orders rose modestly, beating expectations.
- Some commercial real estate is booming Non-mall/open-air strip centers are seeing a rush of activity. Dollar General, Dollar Tree and Five Below, for example, this year expect to open 1,900 locations, up from just under 1,400 in 2022. And other familiar mall names are now focusing on non-mall expansion, including Macy’s, Bloomingdales and Bath & Body Works. As colleague John Sherman points out, industrial warehouses, data centers and cell towers are experiencing a post-Covid boom in demand.
- “Sticky” inflation The Manheim Used Vehicle Price Index has now risen four months in a row, increases that have yet to show up in CPI. And ISI notes that while the surge in layoff announcements should lift unemployment claims, so far, laid-off workers have had little difficulty finding new jobs.
- Bearish technicals The S&P 500, Dow and Value Line indexes have broken uptrend lines from last October, giving rise to fears of a possible retest of October 2022 lows. Fundstrat also notes the about-face in the S&P, giving back most of January’s gains, has caused momentum to turn bearish and intermediate-term breadth to reach levels below December 2022.
- Putting housing in perspective Despite recent improvement, new home sales are down 19% year-over-year, and both inventory and months’ supply of new homes have cooled in recent months. The supply-demand imbalance has new home inventories running 31% below the long-term demographic demand.
S&P’s big two With high cash flows and quality balance sheets—favored characteristics in volatile and uncertain times—mega-cap tech stocks have morphed into a haven trade, outperforming the broader market by their widest margins in decades. At the top are Apple (7.1% of S&P market cap) and Microsoft (6.1% of market cap), whose combined weight of the blue-chip index exceeds a 30-year high.
Business is booming in York Geographically positioned within an eight-hours’ drive of 60% of the U.S. population (also, much of the Canadian population can be reached in one day) is having no pressure on housing prices. A veteran brokerage advisor predicts, “No decline in home prices here.”
We’re going to be fine This feeling washed over me as I presented to the Rotary Club of York, the 26th largest in the world. The meeting started with, “Happy spring!” followed by the Star-Spangled Banner, Pledge of Allegiance, introduction of the mayor of York, announcements for the Turkey earthquake donation, the children’s book drive and the program to help students with post-Covid depression. In attendance were the youth group, the oldest living member of the Rotary and recipients of the college service awards, one of whom shared his dream, which is to complete the CPA exam! Now, I’m teary.