Markets appeared to be mollified slightly over the weekend after the FDIC found a buyer for Silicon Valley Bank. Nevertheless, the quarter point added to the Fed Funds rate last week has increased pressure incrementally on smaller banks trying desperately to maintain their deposit base and compressing their margins, which will result in the further restriction of credit when banks had already been pulling back for risk reasons.
Remarkably, an estimated $500 billion has been withdrawn from small banks in the past two weeks. Banks have borrowed from the Fed’s discount window at an average of $117 billion each night, and an average of $34.6 billion per day from the newly-created Bank Term Funding Program (up from the previous weeks $3.4 billion). It appears some of this borrowing has been very defensive in nature, a desire to build cash reserves for institutions that aren’t under immediate pressure, willing to pledge assets now in case panic spreads.
While SVB was an outlier in terms of its concentrated depositor base, its failure has caused concerns for other banks with significant interest rate exposure and vulnerable, uninsured deposits like SVB. It is estimated that if marked to market the banking sector is sitting on $2 trillion plus in asset declines. Should the economy slow further (expected as credit is further restricted and that is the intention of the Fed’s tightening) then the ability of smaller banks to weather decreasing deposits from companies with shrinking earnings could lengthen this stress.
A majority of commercial real estate mortgages are held by the small to mid-sized banks experiencing the most pressure. While single family 30-year fixed rates are expected to trend down this year, many commercial deals made in a lower rate environment are coming due and will be difficult to refinance, causing further pressure on that sector. In addition to rates disqualifying firms, the willingness of banks to make the loans, especially if the borrowers are money losing operations, will be curtailed, especially when cash yields them 4.5%. That is to say, an economy that slows is likely to cause additional pain. Fannie Mae is saying the recent bank failures may act as the catalyst that tips the economy into a recession, largely due to tighter lending standards by small- and mid-sized regional banks.