by Bryan Perry
August 1, 2023
Rising interest rates, commercial real estate losses, and increased regulatory scrutiny were the buzz phrases facing the regional bank sector in late May and early June, following the collapse of Silicon Valley Bank, Silvergate Bank, Signature Bank, and First Republic. In response to the first failures in late February and March, the Federal Reserve established the Bank Term Funding Program (BTFP) to offer loans of up to one year to eligible depository institutions pledging qualifying assets as collateral.
FRC was closed and sold to JPMorgan Chase & Co. (JPM) on May 1. Since that time, which now seems so long ago, there has not been much in the way of negative bank headlines. After all, the Fed threw the regional bank sector an unlimited line of credit, in which the BTFP authorizes banks to borrow against eligible holdings up to par value rather than market value, a very special arrangement to say the least.
Since bottoming out in early May, the regional bank sector, as measured by the S&P Regional Banking Sector ETF (KRE), has recovered a little more than half its losses from the earlier collapse that took the sector down 46%. But the regionals were already in a protracted downtrend dating back to when the Fed began raising rates in March 2022. Eleven rate hikes later, they are telegraphing that they are not done.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Despite the rally of late, it stands to reason that many of the forces that triggered the regional banking crises in March are still at work. A further bump in interest rates only puts more downside pressure on valuations of securities held by banks, while continuing to incentivize savers to pull money from their accounts, seeking higher yields elsewhere. The biggest brokerage firms are paying around 5% for money market deposits. Those same investors are buying 6-month T-bills yielding 5.5% as of last Friday, making cash management pretty much a no-brainer. Cash goes where it is best served.
The big elephant in the room – losses on commercial real estate loans – are just beginning to show up as a clear and present danger to bank balance sheets. As such, there is likely to be a tsunami of bank mergers forthcoming. Half the country’s banks will likely be swallowed up by competitors in the next decade, according to Fitch analyst Chris Wolfe. “Some of these banks will survive by being the buyer rather than the target,” said incoming Lazard CEO Peter Orszag. “We could see over time fewer, larger regionals.”
Here are a couple of interesting charts. Even as the Fed has quietly increased M2 money supply since April to facilitate more lending by banks, demand for commercial and industrial loans has weakened.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Commercial and Industrial (C&I) loans are loans made to businesses or corporations, not to individual consumers. These loans can be used for a variety of purposes, including capital expenditures (like buying equipment), and providing working capital for day-to-day operations. They are typically short-term loans with variable interest rates. C&I loans are a key driver of economic growth because they provide small-to-medium sized businesses with the funds they need to expand, invest, and hire, which can stimulate economic activity. They are a major line of business for many banking firms, but as interest rates have risen, it has become more expensive for banks to borrow capital to lend out. This increased cost is typically passed on to businesses in the form of higher interest rates on commercial and industrial loans.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
So, with the cost of capital now the highest it has been in over two years, businesses are more hesitant to take on debt, especially floating rate debt, which in turn will likely show up in depressed earnings growth for banks in upcoming quarters. This downward trend in loan demand is being aggravated by a rising rate of delinquencies on commercial property coupled with defaults and foreclosures on residential properties.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
ATTOM, a leading curator of land, property, and real estate data, released its Q1 2023 U.S. Foreclosure Activity Report, which shows a total of 95,712 U.S. properties with foreclosure filings during the first quarter of 2023, up 6 percent from the previous quarter and up 22 percent from a year ago.
The report also shows a total of 36,617 U.S. properties with foreclosure filings in March 2023, up 20 percent from the previous month and 10 percent from a year ago — the 23rd consecutive month with a year-over-year increase in foreclosure activity. A total of 65,346 U.S. properties started the foreclosure process in Q1 2023, up 3 percent from the previous quarter and up 29 percent from a year ago. (Source: https://www.attomdata.com/news/market-trends/foreclosures/attom-q1-2023-u-s-foreclosure-market-report/)
Bear in mind, these are first-quarter numbers, three rate hikes ago. I would venture to say that when the second-quarter data is released, they will show further deterioration, reflected in future bank sales and earnings forecasts and final quarterly results. In my view, the Fed is in its own self-made bind, fighting an inflation that it failed to address early on, being too relaxed on banks with under $250 million in deposits, and now staring at gas prices hitting an 8-month high with the CRB index trading at a 10-month high.
While the market has indeed broadened out in the number of sectors participating in this summer rally, one might consider how much of a weighting that regional banks should occupy in one’s portfolio.
Navellier & Associates does not own JPMorgan Chase & Co. (JPM) in managed accounts. Bryan Perry does not own JPMorgan Chase & Co. (JPM) personally.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
Also In This Issue
A Look Ahead by Louis Navellier
Four Key Sectors to Consider Now
Income Mail by Bryan Perry
The Fed’s Latest Rate Increase and Its Impact on Regional Banks
Growth Mail by Gary Alexander
Economics – The Bountiful Science
Global Mail by Ivan Martchev
The Last ZIRP Man Standing
Sector Spotlight by Jason Bodner
To Broadcast the Truth the Loudest… Whisper It
View Full Archive
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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