Will the Banks Bust the Economy?

Excerpt from Yardeni Research Morning Briefing (March 28, 2023)

Banking I: Disintermediation 2.0? The bear case last year was that the Fed would have to tighten monetary policy aggressively because the Fed was behind the inflation curve and had to scramble to catch up. That would cause a recession, which is the only way to bring inflation down, according to the narrative. As a result, valuation multiples would tumble, and so would earnings.

?That scenario played out well for the bears as the S&P 500 dropped 25.4% from January 3 through October 12 of last year. However, the bear market was mostly attributable to a 29.8% plunge in the S&P 500’s forward P/E (Fig. 1). Forward earnings actually rose 6.2% during the bear market because the recession didn’t happen as expected by the bears (Fig. 2).

?Nevertheless, they are still growling. A recession is still coming, and it will depress both the valuation multiple and earnings, they claim. The forward P/E is up from 15.1 on October 12, 2022 to 17.5 last Friday, but it is likely to fall down to single digits in the bears’ scenario. They’re saying S&P 500 earnings could fall 15% to $185 per share this year, down from $218 last year.

?The banking crisis that started when the FDIC seized Silicon Valley Bank (SVB) on March 10 will cause the credit crunch that causes a recession this year, the bears contend, and sooner rather than later. Money will pour out of bank deposits into safer Treasury securities that are yielding more than deposits. Banks will be forced to sell their underwater bonds. They’ll be forced to stop lending, resulting in a credit crunch. Credit crunches attributable to disintermediation have always caused recessions.

?Banking II: Let’s Make a Deal. That’s all a very plausible litany of what has gone wrong and could continue to go wrong. What could go right is that the banking crisis is contained by the actions taken so far by the Fed and the FDIC. They undoubtedly will respond with more contagion-containing measures if necessary.

?On Sunday, March 12, the Fed provided a new emergency liquidity facility for the banks. According to the Fed’s press release: The Bank Term Funding Program (BTFP) offers loans of up to one year in length to depository institutions pledging US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. “The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress.”

?In effect, the Fed guaranteed 100% of deposits for 100% of depositors by providing the BTFP as a backstop to stop bank runs. So far, so good.

?The FDIC started to do its job immediately after it seized SVB. The regulator transferred all SVB deposits and assets into a new “bridge bank” to protect depositors of the failed lender. On Monday morning, March 27, the FDIC announced that First Citizens BancShares will buy SVB’s deposits and loans, just over two weeks after the biggest US banking collapse since the global financial crisis. The FDIC estimated that SVB’s failure will cost its Deposit Insurance Fund (DIF) around $20 billion, with the exact amount to be determined once the receivership is terminated.

There could be more mergers and acquisitions among the regional banks. To avert disintermediation, they will have to raise their deposit rates, which will squeeze their profitability. That could force many of them to consolidate to lower their costs.

In any event, industry analysts who cover the S&P 500 Regional Banks industry responded quickly to the banking crisis. During the March 16 week, they cut their 2023 and 2024 revenues-per-share estimates by 7.0% and 7.6% (Fig. 3). They reduced their estimates for earnings per share those years by 6.3% and 7.0% (Fig. 4).

Investors slashed the S&P 500 Regional Banks stock price index by 25.8% from March 9 through March 24 (Fig. 5). That caused the forward P/E to plunge from just above 10.0 during February to a record low of 6.3 on March 15 (Fig. 6).

By the way, the FDIC’s Deposit Insurance Fund had a balance of $128.2 billion at the end of last year (Fig. 7).

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