Bank Failures Explained: Questions, Answers and How CRE Fits In

QUESTION NINE

The financial system is much stronger today versus before and during the GFC. In fact, in response to the GFC, the banking system underwent massive reforms to prevent a repeat. Banks are now more capitalized and widely considered better protected for downside scenarios. For example, the 2022 Dodd Frank stress test results revealed that large banks—specifically those with systemic importance—have sufficient capital to absorb more than $600 billion in losses (of which $75.4 billion are tied to CRE). Aggregate capital ratios in 2022 all exceeded the minimum regulatory thresholds at their trough. (We acknowledge, however, that the Fed has only just added sharply higher interest rates into its 2023 stress tests whose results are due in June this year. Regardless, last year’s tests put significant pressure on banks via credit default channels, which is increasingly where there will be focus during the coming year.) Policymakers responded much more quickly today versus during the GFC. SVB collapsed on March 10, and just two days later, regulators acted. They collectively chose to invoke systemic importance clauses, enabling all deposits to be guaranteed. The Treasury and Federal Reserve set up an emergency credit facility for banks facing liquidity issues, providing some initial confidence to the markets. This historic program is likely to redefine how banks are equipped to confront and tackle liquidity crises brought on by interest rate risk. Further, the FDIC is conducting normal, orderly liquidation operations, as it does during any bank failure. Actions during the GFC, in contrast, were largely reactive versus proactive. The Fed provided liquidity to the markets on-demand but with limitations (such as requiring a

high level of credit quality for collateral that financial institutions had to provide to get liquidity). The Fed could not set up credit facilities to address toxic assets without funds from Congress, who took until October 2008 to approve the Emergency Economic Stabilization Act of 2008, which included $700 billion for the Trouble Assets Relief Program (TARP). TARP, in turn, allowed the Fed to create an alphabet soup of facilities to absorb toxic assets from the financial system by providing it with funding to cover losses. Those tough lessons learned showed that fast and decisive action is likely a better approach. This benefitted the U.S. economy and financial system during the pandemic and at present, when regulators did not hesitate to act. There are ongoing concerns around banks’ unrealized losses that stem from interest rate risk on securities on their balance sheets (which is not linked to performance of their credit or outstanding loan portfolios). Today, banks have about 19% of assets in the form of these securities. About half of those are held as “available for sale” (in which case, unrealized losses do flow through and impact capital ratios) and about half are being held as “held-to-maturity” (which do not impact capital ratios and are thus, of more concern). The intent, though, with HTM assets is that banks hold them until they mature. Only if they sell them does a loss result, and that is only if a bank did not have hedging in place to offset that loss (which most banks actually do). If they hold them to maturity, they get every dollar promised in the underlying security. If deposit outflows are gradual and/or a panic is avoided, there is no need to sell these securities at a discounted price. In contrast, during the GFC, banks were facing

Are you concerned this is the Great Financial Crisis all over again?

ANSWER

No, this is not that.

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Bank Failures Explained - Questions, Answers and How CRE Fits In

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