Mission Accomplished?

May 9, 2023

With the Regional Banking ETF (KRE) up over 6% on Friday, is everything OK? Of course not. KRE was still down 10% on the week, even with that bounce, and down 35% YTD. We’ve had four banks with about $500B in assets fail in the last two months. The new BTFP funding program still has $74B of usage in it. Do we really think this is the end of banking problems?

As an aside, it’s worth pointing out what the fundamental problems are. First, there’s a massive differential between short-term rates and bank deposit rates. That’s created what Jim Bianco has termed a “bank walk” on deposits, as the better rates are sought. Why not raise bank deposit rates? That’s the other basic problem. Plenty of business was done in a very low rates environment at low rates. Treasurys were bought hand over fist at low rates, loans were done at low rates, businesses were funded with low rates. The Fed promised rates would stay low for a long time.

Then, inflation forced short rates up, sharply. Let’s say banks did a lot of business at 3%. If their funding costs were 1%, well, that’s not awesome, but you can do fine with that. Raise rates to 5%, and you go bankrupt quickly. Deposit rates actually are going up slowly, but that hits Net Interest Margins. Somebody has to hold those loans and assets, and they’re no longer worth what they were. Rate volatility has deposits walking out the door while bank assets are under pressure. That’s a significant mess.

To add to the mess, banking stress has caused the FDIC to spend a good chunk of money saving banks, and they’re going to have to go back to banks to recapitalize their fund. The Fed has also said tighter regulation is coming, which should hit margins and profitability. Professor Amit Seru of Stanford believes almost half of American banks are now underwater, potentially insolvent. The pressure to increase deposit rates and slow lending isn’t going to help that.

While I think bank stress is still very much present and a problem, I’m not sure it’s the most important problem, right now. Last week, federal authorities were asking for hedge funds to let them know if they’re in trouble. I tend to think something like that only comes up because they’ve been told there are problems. In general, the whole shadow banking system of hedge funds, private equity, and other minimally regulated entities seems ripe for a blowup. I’d look for a “surprise,” soon.

After this blog starts the vetting process to get published, the latest Senior Loan Officer Opinions Survey will get published. So far this year, this survey has told us banks are seeing both weaker demand for loans and tighter lending standards. Presumably, that is only going to get worse, after these bank failures. We had dramatically easy access to credit for quite a while. Isn’t if reasonable that tighter credit will choke off growth prospects? And that lower credit availability will spike defaults? We remain in a situation where there are clear problems, and stocks want to just skip to the end, where the Fed saves the day. That won’t happen with markets so sanguine and inflation so far above the desired trend.


About the Author:

Colin Symons

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About the Author:

Colin Symons

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