​​Banking Failures Explained

Q1: WERE THE RECENT U.S. BANK FAILURES UNIQUE CASES?

A: Unique cases, with a but…

Silvergate reacted to a stunning rate of deposit outflows. SVB recorded explosive growth in their deposits during the pandemic (roughly 200% compared to 35% for all commercial banks); a high percentage of those deposits were uninsured by the FDIC. Signature also had 89% of deposits above the FDIC threshold. 

Q2: HOW COMMON ARE BANK FAILURES?

A: Very common.

In fact, several bank failures typically happen every year, but you rarely hear about them.  Bank failures aren’t rare, but bank runs are. What we observed with Silvergate, Silicon Valley Bank (SVB) and Signature falls into the “bank run” category. 

Q3: GIVEN THE BANKING TURMOIL, HAVE RECESSION ODDS RISEN?

A: In our view, yes – but only slightly.

Recession risks were already high and lending markets were already tightening for the better part of a year leading up to the panic. This episode clearly resulted in a further tightening of credit conditions—which impacts the availability of credit to businesses, particularly for small and medium-sized businesses. 

Q4: HOW IMPORTANT ARE COMMUNITY AND REGIONAL BANKS TO CRE?

A: Important.

Banks typically account for about 42% of lending (the average share from 2017 to 2022), followed by the Agencies/GSEs (23%), CMBS (13%), financial firms (11%), insurance companies (9%) and other (3%). Community and regional banks are the lifeblood of the CRE lending landscape among the banks, which collectively have $2.8 trillion in loans associated with our concept of “CRE.”¹ 

Q5: HOW WILL THE LENDING ENVIRONMENT SHIFT BECAUSE OF THE BANK ISSUES?

A: It will get tighter, but it was already tight.

It’s impossible to have a counterfactual of what CRE lending would look like without SVB, but we know that lending standards by banks had tightened dramatically in the run up (no pun intended!) to recent issues. How can we gauge marginal changes in how risk is being perceived for CRE borrowers? 

Q6: ARE MORE REGIONAL BANKS GOING TO FAIL?

A: Hard to say, but most regional banks should not face the same issues as Silvergate, SVB and Signature. However, no bank, no matter how well-managed, can survive a run on deposits.

As mentioned in another answer, in any given year, we should probably expect at least a few banks to fail. That said, we don’t think most banks will follow the fates of Silvergate, SVB and Signature. 

Q7: WHEN WILL WE KNOW IF THE BANKING CRISIS IS OVER?  WHAT ARE YOU WATCHING?

A: We wouldn’t call three banks out of nearly 5,000 a crisis, but here’s what we are watching. 

Deposit flows, bank lending, Fed balances and job claims. If deposits keep flowing out, that’s a sign of building trouble and a loss of confidence. A sizable increase in the provision of credit by the Fed would signal that ongoing liquidity issues are not resolving. 

Q8: WHAT HAS THE GOVERNMENT RESPONSE BEEN SO FAR TO THE BANKING TURMOIL?

A: Massive response, and fast.

On Sunday, March 12, the Secretary of the Treasury approved systemic risk exceptions for the failures of SVB and Signature. This enabled the FDIC to guarantee all deposits of both banks (SVB and Signature). This action sent signals to the market and consumers that all depositors should have confidence in their bank. The goal was to stymy the panic.   

Q9: ARE YOU CONCERNED THIS IS THE GREAT FINANCIAL CRISIS ALL OVER AGAIN?

A: No, this is not that.

In the run up to the GFC, household mortgage debt represented 63% of GDP and vacancy was higher (reaching ~10% for single-family rental, SFR). Today, household mortgage debt is closer to 45% of GDP and vacant housing is low at 5.4% for SFR. CRE-related debt reached nearly 25% of GDP at the height of the GFC but is now at 17% as of Q4 2022, with the additional backdrop that vacancy rates are generally lower and expected to remain lower than GFC-peak-levels. 

Q10: HAS YOUR OUTLOOK FOR INTEREST RATES CHANGED BECAUSE OF BANKING TURMOIL?

A: Not Really.

Recent issues in the bank sector and the ensuing volatility in rates has not fundamentally altered our view of where they are headed (yet), though we note our outlook here is tied to important incoming data. We believe the Fed will remain focused on its inflation-fighting mandate, and we have one more 25-bps hike penciled in, before they hold through the rest of the year. 

Q11: IF MY COMPANY IS CURRENTLY LEASING SPACE, WHAT DOES THE BANKING TURMOIL MEAN FOR ME? WHAT DO I NEED TO KNOW?

A: There are a few key things to consider.

With the economy slowing and a mild recession as our baseline, we already expected most property types to shift towards a tenant-friendlier environment. Landlords will be looking to fill space amidst broad softening in momentum and the latest volatility will likely give tenants, on average, even more leverage. 

Q12: I KEEP HEARING THAT CRE IS THE NEXT SHOE TO DROP FOR THE BANKING SECTOR. IS IT?

A: Relative exposure matters. So do asset-level dynamics. In other words, citing the infamous show VEEP, “it’s nuanced.”

Any weakness in the CRE sector will pose an added challenge for lenders writ large and banks, particularly those banks whose loan portfolios comprise an outsized share of their assets and whose portfolios are particularly exposed to certain challenged sectors (office and to some extent legacy retail).

Q13: WHAT SHOULD I BE WATCHING AT THIS POINT, AND WHERE ARE WE IN THIS CRE CREDIT CYCLE?

A: It’s the early days, but history has taught us market conditions can change relatively quickly.

It’s good to have a pulse on market indicators. Remember that we should be evaluating all indicators against the form of potential stress or distress they are linked to (whether that be maturity, value diminution or cash flow). Here are a few indicators or real-time themes that we’re watching closely as we monitor broader CRE loan health. 

Q14: WHAT ABOUT CREDIT SUISSE? IS EUROPE’S BANKING SYSTEM IN A CRISIS?  

A: No, definitely not.

Credit Suisse should not be seen as a domino falling in reaction to what has happened in the U.S., nor should it be viewed as a suggestion that a systemic sequence of failures is expected. For contextual background, Credit Suisse has been plagued by a series of scandals and financial losses unique to its own history. Read more about our views on Europe’s banks.