QueensGiant Mid-Year Review

In this edition, we delve into the current state of the capital markets and M&A landscape, with a particular focus on three areas of concern: decreasing money supply, commercial real estate loans, and bank liquidity. As always, our aim is to provide you with valuable insights and analysis to help navigate these challenging times successfully.

Decreasing Money Supply

The global economy experienced a decline in money supply over the past year, primarily due to central banks implementing tighter monetary policies in response to concerns over inflationary pressures. As interest rates rise and quantitative easing measures are scaled back, liquidity becomes scarcer, impacting capital markets and M&A activity.

The ripple effect of Central Banks' interest rate hikes is a shrinking money supply. As a reaction to the pandemic, M2 saw a significant surge. Since then, The Fed reversed course with consecutive rate hikes intended to combat inflation. As a result, we are now witnessing a rapid contraction in M2. The year-on-year decrease in M2 of 2.4% in February, the first since at least 1960, serves as a clear indicator that the Fed might be approaching a pause on rate hikes.?

This reduction in money supply has several implications for investors and dealmakers. It may result in higher borrowing costs, increased competition for available capital, and potentially slower economic growth. However, it is important to note that despite these challenges, opportunities can still arise for those who are prepared and strategic in their investment and M&A decisions. Just as well, it is important to note that this rapid a contraction is unprecedented.

Commercial Real Estate Loans

The commercial real estate sector has been significantly impacted by the changing financial landscape. As money supply decreases and interest rates rise, accessing loans for commercial real estate projects becomes more challenging. Lenders are becoming more cautious, resulting in stricter underwriting standards and reduced availability of credit.

Economic uncertainty, higher interest rates, and a shift to remote work are among the key factors contributing to a tightened financing environment and downward pressure on asset prices. In the next two years, over $1 trillion in loans will mature, creating a 'maturity wall' for property owners to overcome in a higher interest rate market. Financing options have narrowed, forcing private real estate owners to reevaluate their financial strategies and banking relationships. Severe cases may even require significant debt restructuring. Despite these headwinds, some owners are finding creative solutions through bank negotiations and bridge financing. While the environment remains challenging, especially for office loans, we anticipate increased transaction activity as more distressed sellers enter the market. This shift will likely restore confidence in pricing and valuations despite the current challenges.

This tightening credit environment may slow down real estate transactions and impact the valuation of properties. Market participants need to closely monitor evolving lending conditions, consider alternative financing options, and undertake thorough due diligence to navigate these changing dynamics successfully.

Bank Liquidity

Another area of concern is the liquidity position of banks. As monetary policies tighten, banks face increased scrutiny and pressure to maintain adequate liquidity levels. Stricter regulatory requirements, coupled with potential vulnerabilities in certain sectors, could impact the ability of banks to lend and support M&A activity.

As we turn the page of recent financial history, the second-largest depository failure ever recorded, that of Silicon Valley Bank (SVB) with a staggering $212 billion, undoubtedly stands out. This event, second only to Washington Mutual's demise in 2008, is a byproduct of a once-in-a-generation interest rate hike by the Federal Reserve, among other factors, signaling the dawn of a wider banking liquidity crunch.

With the anticipated conclusion of rate hikes this quarter, it's hard to ignore the potential of other banking collapses like those of SVB, Signature Bank and First Republic Bank. Nonetheless, it's important to note that this liquidity scramble doesn't suggest a systemic capital shortfall. The Fed retains about $2 trillion at its repo facility and regulatory capital metrics for the global systemically important banks (G-SIBs) are at their historical best! The table below, provided by Janney, illustrates that in the aggregate the largest banks are well capitalized.

In response to the liquidity challenge, the Federal Reserve launched an emergency "Bank Term Funding Program" (BTFP) on March 12, providing long-term loans to banks against the face value of Treasuries, agencies, and agency MBS. Despite these measures, the stress on the banking system will influence banks to be more conservative in their capital lending to the private sector - a trend we expect to persist over the coming months.

Investors and dealmakers should closely monitor the financial health and stability of their banking partners, assess the availability of credit lines, and explore diverse funding sources to ensure successful deal execution. Establishing strong relationships with banks, that demonstrate resilience and adaptability during challenging times, becomes even more crucial.

Conclusion

The second quarter has undoubtedly shown us that 2023 is not a year for the faint-hearted. Banking institutions, the money market, and commercial real estate all face significant challenges. But, as history has taught us, market turbulence, often a product of the Fed's monetary and fiscal maneuvers, isn't necessarily a sign of doom. Alan Greenspan, former Fed Chairman, once cheekily suggested that monetary policy works "by causing bankruptcies." Hence, let's not be overwhelmed by the storm. Instead let's adjust our sails and be prepared to seize the new opportunities that await.

At QueensGiant, we are committed to providing tailored advice and innovative solutions to help you succeed in these dynamic times. Our team of experts is available to discuss specific strategies and address any questions you may have.

Thank you for your continued trust and support.