Is The Drama Really Over In The Markets? We’re not so sure…

TPP Midweek Market Outlook.

Is it safe to put your head above the parapet yet?

Only time will tell, but advance with caution.

In recent calls with investors, regional bank leaders tried to cast the turmoil in the industry spurred by the collapse of Silicon Valley Bank as a moment that had passed.

A run on deposits at Silicon Valley Bank exposed the risks facing smaller banks across the United States. As we saw in 2008, banking issues that start in the US quickly spread to elsewhere with serious consequences.

For those people who are naive or foolish enough to believe the?latest banking crisis?is over – and there appear to be many of them still, including commentators who should know better – the continuing flight of bank deposits as we saw yesterday must have come as a shock, although it shouldn’t have.

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Shares of?First Republic Bank?plunged more than 22 per cent in after-hours trading last night despite the San Francisco-based lender saying it is taking steps to shore up its balance sheet and cut its workforce as its deposits plunged in the first quarter amid?financial turmoil at US mid-sized banks.

Deposits fell to about $104.5 billion in the first quarter of this year from $176 billion in the fourth quarter of 2022?even after First Republic received a?$30 billion lifeline?from Bank of America, Citigroup, JPMorgan Chase and Wells Fargo, it said in an earnings?statement?on Monday. We suspect the big 4 won’t be up for doing that again.

Without the combined $30 billion provided by America's largest banks, First Republic's decline in deposits would have been almost $102 billion during March after the collapse of?Silicon Valley Bank?and Signature Bank that sparked a run on the lender.

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Shares of First Republic?were down more than 87 per cent since the start of this year as of Monday’s market close.

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Does it sound over?

Even a cursory analysis would suggest that, after a long period of record low interest rates during which borrowing at household, corporate and government levels reached new heights, successive and sharp?rate increases?are likely to have a deep-seated and long-lasting impact. We don’t often know what will break next, but something always breaks.

The reality is that even if the biggest banks are well capitalised and regulated enough to avoid collapse, many smaller banks are suffering from large outflows of deposits.?The widespread credit tightening this is provoking is likely to trigger more than a mild economic recession.

Asia is not immune to this coming crisis either. Even if the shockwaves emanating from the likes of?Silicon Valley Bank?in the United States or?Credit Suisse?in Switzerland are weakening, the fact that Asian economies are more bank-dependent and less capital market-reliant than those elsewhere will tell.

Asia’s corporate sector, and especially that of “emerging” Asia, is highly exposed in terms of borrowing relative to gross domestic product size, according to the Institute of International Finance data at the end of 2022. The ratio for corporate Asia was 130 per cent, well above the 97 per cent figure in mature economies.

Even if many financial analysts and investors have somehow managed to miss the significance of what this combination of high indebtedness with rising interest rates implies for a highly stressed banking sector, depositors have not.

The deposit flight from US banks has been “turbocharged by the collapse of Silicon Valley Bank and?two other US lenders” (Financial Times). Customers have pulled around US$800 billion in deposits from US commercial banks in the past year since interest rates began their rise.

Runs on bank deposits can be partly compensated for by central banks stepping in and providing the affected institutions with?sufficient financial liquidity?to keep going, or by seeking to staunch deposit outflows with?assurances of banks’ soundness.

These are only temporary measures, however. They do not address the now urgent issue of banks, which see their deposits quickly evaporating, naturally becoming nervous about expanding their existing loan books, or even continuing to lend at all, in the wake of such trauma.

As former US Treasury secretary Henry Paulson said in an interview recently, “if you’re running a small or regional bank right now, you wouldn’t be lending”. That leads to a credit squeeze and, as Paulson added, “it’s pretty likely we’ll see a recession” as a result.

Paulson was at the centre of the action during the 2008 global financial crisis, so he knows a thing or two about crises. His expressions of concern about how quickly they can spread with the aid of social media should be taken seriously.

This is a subject that is also beginning to exercise the minds of other responsible people. Hung Tran, a former executive managing director at the Institute of International Finance and now a non-resident senior fellow at the Atlantic Council, is one such voice of caution.

As he has pointed out, the spate of bank failures in March could herald the first banking crisis in a digital world where online banking and rumours spread?on social media?in real time have brought down banks in matters of days, not weeks as in the past.

The abrupt collapse of Silicon Valley Bank and Signature Bank threw the entire industry into turmoil and exposed fissures in the financial foundations of some smaller banks.

A month later,?the nation’s biggest banks are raking in billions?and are likely to keep doing so even if the economy softens. The share price divide will likely increase as the major banks do well, but regional lenders who are more at risk collapse.

Deposits are falling, and the cost of keeping customers is rising, eating into profits. And fears remain about the value of investments and loans, especially ones backed by real estate.

On Friday, Moody’s downgraded the ratings of 11 regional banks, citing “a deterioration in the operating environment and funding conditions.”

Worth mentioning at this point that Moody’s had SVB as an A rating days before the collapse. We’re not sure that they’ve ever once predicted………..well, anything really.

Lenders are calling for calm:

In calls with investors about their latest financial results last week, regional bank leaders tried to cast the crisis as a moment that had passed. The banks also distanced themselves from rivals still caught in the storm, like First Republic.

The runs on deposits that brought about the sudden demise of Silicon Valley Bank and Signature Bank did not spread as widely as some feared. Still, savers seeking the perceived safety of larger institutions took their money out of many smaller banks in recent weeks.

Deposits fell roughly 1 percent, on average, at a selection of about 20 small and midsize banks that reported first-quarter earnings last week, according to analysts at UBS, who described it as “solid” given the circumstances.

In the aftermath of Silicon Valley Bank’s failure, tech clients in particular have bolted from smaller banks.

Western Alliance,?an Arizona bank hit hard by the turmoil, lost more than 40 percent of its deposits from tech clients — and that was still “less than anticipated,” said Kenneth Vecchione, the bank’s chief executive. Overall, deposits at the bank fell 11 percent in the first quarter, as lenders like his were “suffering from the taint of SVB’s failure,” he told analysts. But deposits then stabilized, returning to growth in the first few weeks of April.

Rising interest rates are a blessing and curse for banks.

As the Federal Reserve has raised its benchmark interest rate, banks have increased the rates they charge for loans much more aggressively than what they pay out on deposits. That bolstered earnings at many banks last quarter, including PNC Financial Services, the country’s sixth-largest bank.

A so-called super regional lender based in Pittsburgh, PNC said its first-quarter profit grew nearly 20 percent from a year earlier. But it may not last.

Those loans are financed by deposits, which are becoming more expensive.?

Savers are looking to?money market funds and other higher-yielding options, forcing banks to pay more to hold on to their deposits. At PNC, noninterest-bearing deposits fell 5 percent in the first quarter, while interest-bearing deposits rose 2 percent.

This trend, which is playing out across the industry, reduces profit margins and makes banks more reluctant to lend. The shift in deposits “is, for lack of a better word, ugly,” the UBS analysts noted.

“The marginal cost of funds for the U.S. banking system has just gone up a lot as a result of this flurry,” said William S. Demchak, the chief executive of PNC.

Commercial real estate is a growing worry.

Regional banks provide the bulk of loans to the commercial real estate market, and as more attention turns to the potential risks lurking on bank balance sheets,?these loans are making investors nervous. A combination of office vacancies and a coming wave of refinancings at sharply higher rates has forced many banks to set aside more money to shield against defaults.

The white-collar remote work revolution may permanently reshape the office market, bankers said. “Office is going to be really challenged for quite a few years, and it has a lot to do with remote work,” said Michael Morris, the chief credit officer at Zions Bancorporation, with headquarters in Salt Lake City. The bank increased its allowance for credit losses more than 30 percent in the first quarter versus last year.

Cleveland-based KeyBank, one of the nation’s largest commercial real estate servicers, has seen what Christopher Gorman, the bank’s chief executive, described as a “huge surge” in demand for special servicing, the process for handling troubled loans. Office projects have recently eclipsed retail buildings as the biggest category of loans in special servicing, Mr. Gorman said.

A credit crunch could tip the economy into recession, hurting banks’ profits.

Banks are tightening their lending standards, though they have cast the changes as tweaks, not a major pullback.

“We try to be the same through good times and bad, right, because what our clients value is consistency,” said Darren King, the chief financial officer at M&T Bank, with headquarters in Buffalo.

Still, echoing?the warnings that big bank leaders have been issuing, smaller banks are bracing for a downturn. Bruce Van Saun, the chief executive of Citizens Financial Group, based in Providence, R.I., said his bank was adjusting its lending decisions to account for the likelihood of “a short, shallow recession.”

Truist, the nation’s seventh-largest bank, with headquarters in Charlotte, N.C., said it was being more cautious about extending credit in what Michael Maguire, the bank’s chief financial officer, called “an increasing risk environment.”

But many are saying they believe that the tumult set off by Silicon Valley Bank’s collapse is now in the rear view mirror.

“The waters are calmer,” said Mr. Vecchione of Western Alliance. “I like to think we did OK through this whole crisis here.”

Western Alliance was downgraded two notches by Moody’s, which cited concerns about the bank’s rising credit costs and reduced profitability. As I mentioned, they’re great at telling what’s already happened.

Speaking two days earlier, Mr. Vecchione added a note of caution to his comments: “I want to be careful that I’m not like George Bush, that things are signed on the aircraft carrier that says ‘Mission Accomplished,’ right?”

What happens next is mostly out of the banks’ hands. If depositors sit tight, behave like grown-ups and leave their money where it is, then it could well be over. BUT, that just isn’t what people tend to do. People panic, and social media adds to that panic. Bank runs could quite possibly become a regular occurrence.

For now, things feel calmer, but yesterday’s selling of First Republic makes us question whether that will last.

The current TPP market bias:

The majority of our traders have just completed an excellent Q1, in what was a very challenging trading climate.

It seems that the majority of the ‘buy or flats’ and the ‘active’ strategies?timed many of the short/mid term moves fantastically well.

As of right now- our overall bias is one of a SELL variety. If markets retrace a touch from here- we’ll be very well positioned to take advantage.

One thing?is for sure, our traders will be looking to start this quarter like they ended the last one.

If you have an underperforming portfolio or are sitting in cash waiting for an opportunity- contact our team for a FREE consultation.

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