Bank Failures Explained: Questions, Answers and How CRE Fits In
Are you concerned this is the Great Financial Crisis all over again?
No, this is not that.
A credit crisis in the largest and most important debt market—that of single-family residential mortgages. These are two very different challenges, with very different underlying causes. While a credit cycle is underway and in its early stages, the recent failures of the three aforementioned banks have nothing to do with credit and instead relate to the ramifications of a rising-rate environment and the resulting impact on bond and securities values, as well as their over-reliance on uninsured deposits and specific sectors. The size of the problem today is much smaller. In the run up to the GFC, household mortgage debt represented 63% of GDP and vacancy was higher (reaching ~10% for single-family rental, SFR). Today, household mortgage debt is closer to 45% of GDP and vacant housing is low at 5.4% for SFR. CRE-related debt reached nearly 25% of GDP at the height of the GFC but is now at 17% as of Q4 2022, with the additional backdrop that vacancy rates are generally lower and expected to remain lower than GFC-peak-levels, except for office which set a new peak vacancy rate record in Q1 2023. Further, while SVB and Signature were sizable banks, they pale in comparison to Lehman Brothers, Bear Stearns, Merrill Lynch, Washington Mutual, Wachovia and AIG. Derivatives, which contributed to the panic during the GFC and a general distrust of counterparties, underwent reforms like the bank sector and are now registered with clearing houses. Generally most measures of derivatives activity are in much healthier territory than pre-GFC.
Has your outlook for interest rates changed because of banking turmoil?
Forecasting interest rates is not for the faint of heart during normal times let alone during periods of elevated uncertainty. Since the pandemic, it feels as though we’re operating in an environment where uncertainty is higher (certainly than it was in the last cycle). However, recent issues in the bank sector and the ensuing volatility in rates has not fundamentally altered our view of where they are headed (yet), though we note our outlook here is tied to important incoming data. We believe the Fed will remain focused on its inflation-fighting mandate, and we have one more 25-bps hike penciled in, before they hold through the rest of the year. Inflation has remained stubborn and the Fed’s measures of supercore/core services inflation has been reaccelerating in recent months. Ultimately, the convergence of tighter credit and slowing growth (and ultimately a mild recession) will help bring inflation down (on top of other factors that will cause it to slow), thereby allowing the Fed to pivot by spring of 2024. When this happens, we believe bond markets will price a new growth cycle, causing the yield curve to un-invert, thereby pushing up rates at the long end of the curve. Over our forecast, we call for relative spreads between the fed funds rate, the 10-year Treasury and the Baa corporate bond to normalize, putting us in a camp that believes H1 2024 will be when rates are highest. We will learn a lot in the coming months—about inflation, labor market strength and financial stress—and we will update our views as and when needed.
Bank Failures Explained - Questions, Answers and How CRE Fits In
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