The Banking Sector Moving Forward

Telemus Weekly Market Review March 20th - March 24th, 2023

March has been an eventful month for the banking industry. As we look back on the events of the past two weeks, we do believe the sector has been weakened because of the recent bank failures. The issues surrounding the demise of Silicon Valley Bank and others highlight the impact that higher interest rates have had on bank balance sheets. In addition, it has forced depositors to revisit their FDIC insurance coverage and the yield they are earning on their account balances. 

We can’t pretend to be able to forecast whether there will be any additional bank runs like the one experience by Silicon Valley Bank. Events like these are behaviorally driven, and while we believe the Federal Reserve has taken prudent steps to ease any future bank runs, they can’t prevent them. However, as we look ahead, we expect the banking sector will need to cope with several evolving trends.

First, the Silicon Valley Bank (SVB) experience is prompting depositors to consider reallocating any deposits they have in excess of current FDIC insurance coverage that extends to $250,000 per depositor, per institution. As concerns around bank stability have emerged, the largest banks such as J.P. Morgan, Wells Fargo and Bank of America have benefited given their strong liquidity position and perception as being ‘too big to fail’. As depositors have migrated to these institutions they may be electing to sacrifice a lower interest rate on deposits in exchange for perceived safety. Outside of the large institutions, we expect the exercise of revisiting deposit coverage to prompt other depositors to be more attentive the interest rate they are earning on deposits. During 4th quarter 2022 earnings calls hosted by banks back in January, some CEOs had speculated deposit betas, or the percent of future interest rate increases they expected to pass on to depositors, would be in the 50-60% range. We would posit after the SVB collapse, if anything deposit betas may indeed be higher for the industry, although the larger systemically important banks may not face as great of a headwind. An alternative competitor for banks is likely to be lower risk investment securities such as money market mutual funds and Treasury bonds. Money market funds, for example, have seen inflows of $193 billion in just the first three weeks of March alone. 

Should the outflow of bank deposits continue, we would expect the impact to be more pronounced among smaller community banks that are more dependent on core checking and savings account deposits. These banks often don’t’ have as much exposure to other funding sources such a publicly traded bonds. Liquidity starved banking institutions could be attractive acquisition candidates for larger banks with more stable funding. As the year progresses, we would expect to see an acceleration in bank mergers. 

Another area of impact is likely to be reduced lending. As banks consider an increased need for liquidity, it seems likely that many will pull back on the number of loans they are willing to commit to. Not only could this slow growth but it could hamper some businesses that are more dependent on loans to support their growth. Even more specifically this could impact the commercial real estate market in an outsized way. Community banks account for 80% of loans to commercial real estate borrowers. Given the valuation disparity that already exists in the real estate market, a reduction in commercial real estate lending is likely to add further stress on the sector. We do not expect residential real estate to face the same stresses given the ample amount of government funding that supports residential mortgages. 

The conditions impacting the banking sector are unique. The industry can work through the liquidity concerns that have stressed the industry over the past few weeks. However, we do believe the impacts will be more than transitory and are worth being mindful of moving forward. 

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