Affordability

Both Warren Buffet and Jamie Dimon said in the days following the JPMorgan take-over of First Republic that the banking crisis is over, two pretty good sources on banking stress. It doesn’t mean there won’t be more bank failures—it seems inevitable there will be in the months ahead with the Fed tightening another quarter point last week putting several more under increased pressure. But it may mean from their vantage point banks with the interest rate exposure and those likely to feel the most pressure are small enough that consolidation is not going to cause contagion. It also means, however, that credit conditions will continue to tighten, slowing the economy. With the continued robust consumer activity and strong employment, however, that expected slowing appears slightly delayed and/or softened.

The banking credit tightening is certainly part of the story here because it may give the Fed room to stick with the plan to pause (in June) in order to observe whether recent rate moves are having the intended effect on inflation. The Federal Reserve survey of bank loan officers, out Monday, showed that credit conditions for U.S. business and households continued to tighten in the first months of this year.

In housing, the Mortgage Bankers Association (MBA) reported that mortgage credit availability fell in April to its lowest level since 2013, “matching the tightening in broader credit conditions stemming from recent banking sector challenges and an uncertain economic outlook,” Joel Kan, MBA Vice President and Deputy Chief Economist said.

MBA’s SVP and Chief Economist Mike Fratantoni perhaps summarized the current status well following the Fed statement last week: “We expect that the Fed will be ‘data dependent,’ and certainly would react to any renewed increase in inflation, but [the statement made by Chairman Powell] is consistent with a plan to pause rates at this level. Inflation is likely to trend down over the course of the year, particularly as weakness in the rental market begins to be reflected in the inflation numbers. In the near term, tighter credit conditions will slow the pace of economic activity. The housing sector is already operating under tight credit, so we don’t expect this headwind to outweigh the benefits from somewhat lower mortgage rates. The housing market is likely pulling the economy out of this slowdown, as it typically does.”

Activity at the Fed’s discount window and the Bank Term Lending Program rose in the past week, with banks borrowing $73 billion from the window and $82 billion from the program, up slightly and continuing to stay at high levels. With the seizure of First Republic Bank over the weekend and JPMorgan picking it up early Monday, pressure continues on banks that are similarly exposed to interest rate risk and risk of deposit flight. The Federal Home Loan Banks said advances rose 28% at the end of the first quarter from the close of 2022, reaching a record $1 trillion during the March banking crisis, slowing toward the end of the month.

Following the First Republic deal, shares of a few other banks — Comerica, PacWest Bancorp, Western Alliance Bank and Zions Bank — all sank in Tuesday trading.  Eyes and ears will be on whether these potential failures cause dissenting votes Wednesday within the FOMC.

First Republic was the 14th largest bank at the end of 2022 and is now the second largest bank failure in history after Washington Mutual in 2008, which JPMorgan also acquired. Of note here is that JPMorgan will share a loss with the FDIC on loans, with the FDIC reportedly taking 80%. Commercial real estate loans were reportedly a relatively small portion (6%) of First Republic’s loan base. The residential mortgage loans are believed to be low interest, low LTV loans to good credit borrowers. Nearly 60 percent of First Republic’s loans were single-family mortgages, according to their most recent annual report.

The Wall Street Journal reports that home builders are enjoying stronger-than-expected business this spring, capitalizing on the recent fall in mortgage rates and the shortage of existing homes for sale. Active listings in March stood at roughly half of where they were four years earlier, according to realtor.com, in part because higher mortgage rates made many homeowners reluctant to sell and give up their current low rates, the Journal said. WSJ said newly built homes made up “about one-third of single-family homes for sale in March, according to data from the Commerce Department and the National Association of Realtors. The proportion of newly built homes reached nearly 35% in December, a record in data going back to mid-1982 and up from a historical norm of 10% to 20%.”

Redfin reported more house hunters are returning to the market as mortgage rates and home prices continue to decline, but low inventory is hampering their searches.

Banks continue to borrow from the new bank term funding program, up $10 billion last week to $64 billion while  borrowing from the Fed discount window slowed to $88 billion, down $22 billion according to CNBC’s Steve Liesman.  All told, in the month of March, the Fed increased its balance sheet a net $324 billion, although during this past week the Fed’s balance sheet actually declined as they did let MBS and Treasuries roll off — short of their targets but after rising in recent weeks appears to indicate some calming of the crisis, at least for the time being.

Outflows from small banks slowed to $1 billion, CNBC reported, and we saw outflows from large banks to the tune of $96 billion — $65 billion was transferred to money market funds last week, half the week prior, but it set a new record of $5.2 trillion in money market funds as we see the desire for yield play out. Although they are not insured deposits, those investments are mostly in government securities.

Despite the borrowing from the banks, at least for the Fed discount window, appearing reach a crescendo, there are still signs of further weakness and continued fears of a broader recession. One such marker is the growth in the money supply and the velocity of money, which has slowed significantly. Despite the Fed lending to banks, total outstanding liabilities in the banking system are declining rapidly. Morgan Stanley says bank liabilities are falling at a rate of 7% year-over-year, the biggest decline in more than 60 years, which suggests both economic and earnings growth are likely to remain under pressure.

We mentioned commercial real estate lending last week. Morgan Stanley says 70% of the core CRE debt in the banking sector was originated by regional banks, and much is maturing in the next few years — about $550 billion needing to be refinanced per year until 2027 ($450 billion this year).  Even where the CRE lending is done by other banks, they point out, these small and medium size banks are buyers of senior tranches of agency commercial mortgage-backed securities. “If their ability to buy these securities decreases because of new regulations, this indirectly impacts the prospects for refinancing maturing debt in the sector as well,” Morgan Stanley’s chief fixed income strategist said.