The US financial system is still suffering from the collapse of Silicon Valley Bank (SVB) and Signature Bank, the second and third largest bank failures in history.
Despite the turmoil, regulators and bank executives say they don’t expect a repeat of the 2008 financial crisis — but they warn the banking sector isn’t out of the woods just yet.
Banks face huge unrealized losses on long-term investments, the threat of further bank runs and the threat of default in the commercial real estate market. If banks are stressed, they could cut lending and hurt the economy.
Here are some of the trouble spots that are still on the radar of the banking sector and market watchers.
Treasury Secretary Janet Yellen. (The hill).
US banks face $620 billion in unrealized losses
SVB’s technology and venture capital clients withdrew their money amid concerns about the bank’s massive unrealized losses on its long-term government bond investments. Outflows forced SVB to sell securities at a loss to raise money, but the bank still failed to remain solvent.
Banks of all sizes made similar bets on government and mortgage-backed bonds.
Although typically a safe haven investment, these securities fell in value when the Federal Reserve aggressively raised interest rates, pushing up yields on new bonds and making older bonds less attractive.
According to the Federal Deposit Insurance Corporation (FDIC), US banks had a whopping $620 billion in unrealized losses on these types of securities at the end of 2022.
Problems on the Horizon? The impact of bank failures is far from over, lawmakers say
Many banks may have to sell them at huge losses when faced with liquidity problems.
Analysts have pointed to large unrealized losses at regional banks that experienced deposit outflows following the collapse of the SVB. While larger banks also face losses, it’s a smaller percentage of their assets, so they don’t face the same risk of a bank run.
“It’s not a problem unless your depositors decide it’s a problem and demand their money back, which is what happened at Silicon Valley Bank,” said David Sacco, a finance professor at the University of New Haven.
After the collapse of the SVB, the Fed created a lending program designed to allow banks to process customer withdrawals without having to sell securities. According to experts, this has helped reduce the risk of unrealized losses.
Federal Reserve Chairman Jerome Powell adjusts his tie before discussing his semi-annual monetary policy report to Congress before the House Financial Services Committee on Wednesday, March 8, 2023.
Medium-sized and regional banks are still threatened by bank runs
Perhaps the most immediate threat to the banking system is the outflow of funds from mid-sized and regional banks, which are an important part of the US financial system.
Wealthy depositors shifted their funds from these banks to larger institutions fearing further bank runs. San Francisco’s First Republic Bank lost some $70 billion in deposits within weeks of the SVB’s collapse, prompting major banks to throw a lifeline to the lender.
While the FDIC only insures deposits up to $250,000, federal agencies used an exemption to insure all deposits with SVB and Signature Bank to boost confidence in the banking system.
Blow to market confidence: How the fight over the debt limit could affect the banking crisis
Treasury Secretary Janet Yellen indicated that regulators would take the same step in the event of future bank failures, which would slow the outflow of funds from banks with high levels of uninsured deposits.
“This banking system is built on trust,” Sacco said. “A certain percentage of all bank assets are illiquid, so the nature of our banking system is such that basically every bank would fail if everyone wanted their money back.”
The panic seems to have subsided. Total deposits at US commercial banks reached $17.35 trillion at the end of March, up from $17.31 trillion a week earlier but still below the $17.62 trillion at the start of the month, the Federal Reserve data.
Upcoming earnings reports and subsequent stock sell-offs could halt this momentum. First Republic Bank is due to release its first-quarter earnings on April 24, nearly two weeks later than expected. The bank’s shares have fallen by around 90 percent since the beginning of March.
A person walks past the headquarters of First Republic Bank on March 13, 2023 in San Francisco, California. (Photo by Justin Sullivan/Getty Images)
“There are clearly ongoing market fears,” said Karen Petrou, managing partner at research firm Federal Financial Analytics. “If there are surprises in earnings, particularly from some regional banks where markets are particularly scared, it could trigger another rush or market reaction.”
As banks seek to bolster deposits, they face increased competition for cash. Rising interest rates are making bonds, money market funds, and other investments a more lucrative place for individuals and businesses to store their money.
Regional banks are paying over 5 percent interest on certificates of deposit — where a person agrees to keep their money in the bank for a set period of time — down from less than 1 percent a few months ago.
US banks hold $3.1 trillion in commercial real estate loans
Smaller banks are particularly vulnerable to a downturn in the commercial real estate market.
The explosion of remote and hybrid work during the pandemic has left office buildings emptier than intended, hurting the value of buildings owned by commercial real estate companies that have mortgages with banks.
According to the National Association of Realtors, office vacancy rates have increased in about two-thirds of areas in the US compared to pre-pandemic levels.
Is a recession more likely? JPMorgan CEO says banking crisis “puts another weight on the scales” towards recession
Some analysts worry that vacancy rates will only rise if more companies are walking the distance and refusing to renew their leases.
Analysts at Goldman Sachs estimate US banks held $3.1 trillion in commercial mortgages as of the start of the year. Small and regional banks hold about 80 percent of commercial real estate loans, the analysts said.
Default rates are rising and $270 billion in commercial mortgages held by banks will mature this year, according to market research firm Trepp.
With the Fed raising interest rates and banks growing concerned about the commercial market, loans are having to be refinanced at higher interest rates. If borrowers are unable to refinance and meet their obligations, banks could suffer a “default wave,” Petrou said.
Downtown San Francisco has become a case study of what happens when commercial real estate markets collapse. (Photo by Justin Sullivan/Getty Images)
Mortgage lenders lose money on loans when lending continues
US banks’ commercial lending fell nearly $105 billion in the last two weeks of March, according to Fed data released on Friday. The decline, buoyed mostly by small banks, was the largest on record, Bloomberg reported.
The American Bankers Association’s credit condition index, released on Thursday, fell to its lowest level since the pandemic began.
Sayee Srinivasan, the association’s lead economist, pointed to “elevated uncertainty and broader economic headwinds.”
Lending troubles: Mortgage lenders are losing money on loans for the first time in years
“Lenders are responding with cautious and prudent underwriting,” Srinivasan said in a statement.
While a slowdown in lending would affect bank profitability, it is a greater risk to the economy in general, which relies on financing to grow and create jobs.
Fed Jerome Powell said last month that officials are watching credit availability closely as they consider whether to continue raising interest rates to cool inflation.
“It could easily have a significant macroeconomic impact and we would factor that into our policy,” Powell said.
Banks sometimes regulated themselves, so we don’t know what we don’t know
Powell and other federal regulators have said banking rules need to be reviewed after regulators failed to prevent SVB’s collapse.
SVB and Signature Bank have lobbied for a 2018 bill to relax regulations for mid-sized banks so they are not subject to stress tests and capital requirements. The Fed decided against stricter supervision of legally licensed mid-sized banks.
President Biden is also urging lawmakers to tighten banking regulations to reduce the likelihood of future bank failures.
Existing rules also make it harder for investors to identify bank risks, some critics say, and banks have often found ways to reclassify losses.
Black unemployment is at an all-time low — but ‘awful’ working conditions still bog many GOP ahead of a difficult budget battle as it nears 100 days in power
For example, some banks with large unrealized bond losses have employed accounting tactics to prevent billions of dollars in losses from appearing on their balance sheets by declaring that they will hold the securities to maturity. This particular maneuver has been dubbed “switcheroo” and continues to be closely scrutinized by regulators and investors.
Credit Suisse bondholders are exploring legal options after Swiss regulators wiped out around $17 billion worth of bank bonds, known as CoCo or A1 bonds, as part of the bank’s collapse and subsequent sale to UBS last month.
They were invested in high-yielding contingent convertible bonds, which banks issued after the 2008 financial crisis to shift risk to investors and avoid government bailouts. These too are subject to scrutiny by local and global regulators alike.
Copyright 2023 Nextstar Media Inc. All rights reserved. This material may not be published, broadcast, transcribed or redistributed.