March 21, 2023
🌅 Good morning! It's Emily and I'm counting down the days until the Season 4 premiere of Succession on HBO. Thankfully, we did get a little real news about an old media titan yesterday to tide us over till then.
In the meantime, let's talk banks.
Today's newsletter is 1,104 words, 4 minutes
1 big thing: Small banks, big problems
A pullback in lending among small banks in the U.S. was already underway before the collapse of Silicon Valley Bank and Signature Bank. Now economists expect to see more tightening, Emily writes.
Why it matters: Stricter lending standards among smaller banks is likely to slow economic growth overall. But the commercial real estate sector, already battered by rising interest rates and half-empty office buildings, is particularly at risk.
The big picture: Big banks get a lot of attention, but there are about 4,800 banks in the U.S. — and the small ones play a large role in the economy, as a recent Goldman Sachs report notes.
- Small and midsized banks, defined as domestically chartered banks not among the 25 largest, currently hold 67.2% of all outstanding commercial real estate loans, and 37.6% of loans overall. (h/t: Wall Street Journal for chart inspiration.)
- These small players grease the wheels of the economy in all kinds of ways, particularly in specialized areas and regions. Think, Signature Bank's lending to Broadway or SVB's lending to startups.
Zoom out: By the end of last year, banks were already pulling back on lending, as they saw more deposits head out the door, said Chad Littell, CoStar Group's national director of U.S. capital markets analytics.
- Regular consumers had burned through excess savings and needed money to pay the bills. And some companies — like the tech startups who banked at SVB — were seeing a greater need to access their cash, too.
- About 40% of loan officers said they had tightened lending standards in the commercial real estate space during the last quarter of 2022, per an analysis of the Fed's most recent quarterly survey of loan officers by CoStar. Only about 5% said they were tightening at the end of the previous year.
Meanwhile: Another huge area of office building financing — the market for commercial mortgage-backed securities (CMBS), where banks bundle the loans and resell them to investors — is seizing up. Sales of these deals were down 85% in February, compared to last year, per Bloomberg.
Between the lines: The failures of SVB and Signature are likely to accelerate the pullback. "The banking sector, which was already limiting its exposure to real estate, may look to restrict lending even further after the recent collapse, especially among regional and community banks," Littell wrote in a recent report.
- Yes, but: Since lending standards were already tight, it's possible the impact of these recent bank failures "might be more limited," write the Goldman authors.
Where this surfaces first: Probably in the most distressed part of the real estate sector, offices — particularly Class B.
- Those most at risk: Companies with floating-rate loans whose interest burdens have become increasingly unaffordable or those with loans scheduled to mature soon. "That's probably the biggest area of concern," Littell said.
What to watch: How this pullback trickles out to regular folks and the economy — and whether it makes it harder to get car loans or other kinds of consumer loans.
2. Catch up quick
3. The bond market's take on recession risk
If you’re looking for market signals about recession risk in the aftermath of Silicon Valley Bank’s collapse, look no further than the high-yield bond market, Axios' Kate Marino writes.
Why it matters: The simmering banking crisis that sprang into the open this month has raised concerns that the flow of credit from regional banks into the economy could slow, as we wrote above. Such a slowdown could pinch the economy, or even help tip it into a recession.
- Concerns like this tend to be most visible in the high-yield bond market, since that’s where companies with the lowest credit ratings — and who are the most vulnerable in a recession — borrow money.
What happened: High-yield bonds' spread over Treasuries — a measure of how much investors are being paid to lend to high-yield companies, compared to lending with the U.S. government — have shot up by an eye-popping 1.22 percentage points in the last two weeks alone.
- Treasury yields themselves have actually gone down over this period — amid an overall flight to quality — while high-yield bonds headed in the opposite direction.
- That means investor perceptions of actual credit risk, not just interest-rate risk, have grown dramatically.
The kicker: Spreads crossed the 5-point mark last week — traditionally something of a red line indicating higher-than-average risk in the market.
- What they're saying: The market is telling us that "the risk of recession in the second half of the year has intensified," says Ken Monaghan, co-director of high yield at Amundi US.
4. 🏚 Comparing housing slumps
The Fed's rate hiking campaign has brought activity in the U.S. residential real estate market to a crawl. But prices have barely budged, Matt writes.
The big picture: In other countries, the impact of higher rates on home prices is way more pronounced, according to a new report published by The Organisation for Economic Co-operation and Development (OECD).
State of play: Like the U.S. Fed, central banks around the world have fought against a surge of inflation with a flurry of interest rate increases, which have raised mortgage rates — making housing more costly to finance and driving sale prices lower.
Details: The deepest downturns in prices are in New Zealand and Sweden, two nations that saw surging home prices earlier in the COVID crisis. And the majority of borrowers in both countries have floating rate mortgages that reset with rising interest rates, which means household finances are put under pressure quickly — forcing some owners to sell.
- In contrast, the percentage of variable rates in countries like the Netherlands is much lower. The Netherlands and Denmark also have fairly large systems of subsidized public housing, meaning that people who, in countries like Sweden, might stretch to buy — and then be forced to sell — are more insulated from the rate increase.
- In the U.S., home of the uniquely American 30-year fixed-rate mortgage, the price impact — at least so far — of the rise in rates has been muted. "Golden handcuffs" — mortgages taken out while rates were low — incentivize people to hang onto their home rather than trade up to a new one.
The bottom line: Countries have different systems, and it's hard to say what's better or worse. More rate-sensitive housing markets like Sweden (where some mortgages reset every three months!) could result in a bit more affordability — and volatility — over time.
1 fun thing: On the occasion of Howard Schultz stepping down as CEO of Starbucks, again, you might want to check out the history of the Frappuccino in Saveur. It didn't start out quite so sugary — nor was it invented by Starbucks.
Editor’s note: The item about the Los Angeles school district has been corrected to show that the strike is by service employees, not teachers.
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Today's newsletter was edited by Kate Marino and copy edited by Lisa Hornung.