Are problems in the banking sector “over”? … why we’re not out of the woods yet … a live event with Louis Navellier next Tuesday to discuss banking stress … the next domino to fall
“This part of the [banking] crisis is over.”
That was JPMorgan CEO Jamie Dimon on Monday.While some found the comment reassuring, to me, it magnified a question…What other “parts” of this mess are out there?Dimon did not spell that out. He did, however, offer the following nugget, which did not find its way into nearly as many financial headlines as the “this part is over” line:
Obviously, going forward, [if] you have a recession, rates going up and stuff like that, you will see other cracks in the system. That’s to be expected.
Almost on cue, the very next day [Tuesday], the price of two new regional banks began tumbling as worries about their health mounted.Here’s CNBC:
Regional bank stocks fell sharply Tuesday as the fallout from the third major bank failure this year continued to put pressure on the sector.Shares of PacWest fell nearly 28% on Tuesday and was on track for its fourth-straight negative session. The stock was halted for volatility multiple times.The California-based bank was not the only regional lender under pressure. Shares of Western Alliance dropped 15%.
As I write Thursday morning, it’s getting worse.Back to CNBC for the latest:
The rout in regional banks picked up steam again on Thursday morning, with several stocks suffering sizeable losses.PacWest sank 45% in early trading and was halted for volatility. The slide began on Wednesday evening following news that the Los Angeles-based bank was exploring strategic options, including a potential sale.
And what about Western Alliance?It’s down more than 55% at the moment.But don’t worry! This part of the crisis is over!(By the way, First Horizon is down 38% as I write, but that’s attributed to its scrapped merger with TD Ameritrade.)
If we look at the entire regional bank sector, this week’s drop is just the latest in an ongoing bloodbath since in February
To illustrate, below, we look at KRE, the SPDR S&P Regional Banking ETF. Since early-February, it has lost 46%.
The pain began earlier this year with a string of bank failures.To make sure we’re all on the same page, we’ve had three bank collapses so far in 2023: Silicon Valley, Signature, and now, First Republic, which goes down as the second-largest bank failure in U.S. history.Dimon suggested the worst is over, but many banking analysts don’t hold that opinion.From David Pierce, director of strategic initiatives at GPS Capital Markets:
Jamie Dimon comes out and says ‘this is it, this is the end of it, we’re all good now’ — I don’t think we can really say that yet, because we don’t know what other problems might be lurking.And obviously there are some things that are hidden, and a lot of this also comes down to there’s been some mismanagement of these banks.
As we’ve profiled here in the Digest, one of the biggest unknowns is the extent to which trouble in the commercial real estate sector will hit smaller banks
Here’s The Wall Street Journal reporting on the connection between commercial real estate and small banks (bold added):
Smaller banks are crucial drivers of credit growth, the fuel that powers the economy.Banks smaller than the top 25 largest account for around 38% of all outstanding loans, according to Federal Reserve data.They account for 67% of commercial real estate lending.
If you’ve been following our ongoing “commercial real estate watch” segment here in the Digest, you know the commercial real estate market is suffering.Commercial real estate is highly-leveraged. As rates have exploded over the last year, real estate companies with variable-rate loans and/or refinancing needs have increased exposure to these higher rates. And don’t think that commercial real estate companies knew better than to use variable debt.Bloomberg reports that nearly 48% of debt on office properties that matures this year has a variable rate. Translation: Costs are going up – way up.But that’s only half of the equation. What about revenues?Well, as “work from home” remains popular, demand for commercial real estate space has dropped, which reduces rents and revenues. Lower revenues mean reduced profits.Reduced profits mean a company may not be able to pay its debt service – but it also means that if a distressed company has to sell a commercial real estate building, that sale price will be far lower than it was just a few years ago.We provided an illustration of this earlier this week.In San Francisco, the 22-story office building at 350 California Street was worth around $300 million in 2019, according to estimates.According to The Wall Street Journal , it’s now on sale, and bids are expected to come in at about $60 million. If so, that will be an 80% decline in value in just four years.Do you think that kind of price-haircut is going to hurt whatever bank financed 350 California?
Legendary investor Louis Navellier is increasingly concerned about what he sees happening in the banking sector
Regular Digest readers know that Louis is a market legend – one of the first “quant” investors to use computers and algorithmic trading to generate superior investing returns.But what you might not know is that Louis used to work in banking. From 1978 through 1982, he worked for the Federal Home Loan Bank of San Francisco. It’s what he saw while working in the sector that’s resulted in his avoidance of most banking stocks in the decades since.Today, Louis is watching what’s happening with growing concern. In fact, his alarm has risen to such a degree that next Tuesday May 9th, he’ll be holding a live event to discuss what’s happening, what he sees coming, and what to do about it from an investment perspective. Louis believes there’s a much larger story here that you’re not getting from the media.We’ll bring you more details over the coming days, but for now, you can reserve your seat for the event by clicking here.
Finally, consider how, if distress in small banks is just the next domino to fall, what happens after that?
Well, it spreads to the broad U.S. economy.Consider why…One of the critical functions of banks is to loan to businesses of all types, operating in sectors throughout the entire economy. This enables these businesses to grow, which expands our broad economy, adds jobs, and increases the overall quality of life for everyone.But when banks fail, they batten down the hatches, tightening their lending standards to prevent additional losses from new, failing loans.Less money available for economic growth slows the economy, increasing the recession risk that’s already incredibly high today.That’s where it appears we’re headed.Here’s Goldman Sach’s take:
As stress ripples through smaller banks in the U.S., the tightening in lending standards among those institutions is expected to reduce economic growth this year…While the macroeconomic impact of a pullback in lending is highly uncertain until the extent of the stress on the banking system becomes clear, economists in Goldman Sachs Research lowered their forecast for U.S. fourth-quarter GDP growth (year-over-year) by 0.3 percentage point to 1.2%. The new estimate incorporates expectations for tighter lending and reflect in part a larger downgrade to investment spending.Small- and medium-size banks play an important role in the American economy. Lenders with less than $250 billion in assets account for roughly 50% of U.S. commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending and 45% of consumer lending…To the extent that banking stress that started with the resolution of Silicon Valley Bank has an impact in lending, it’s likely to be concentrated in a subset of small- and medium-sized banks.Our economists expect lending standards will tighten more, to a degree that’s greater than during the dot-com crisis, but less than during the financial crisis or the height of the pandemic.
None of that sounds good. But how much of this is just concern versus current reality?Well, here’s Axios:
By the end of last year, banks were already pulling back on lending, as they saw more deposits head out the door…About 40% of loan officers said they had tightened lending standards in the commercial real estate space during the last quarter of 2022, per an analysis of the Fed’s most recent quarterly survey of loan officers by CoStar.Only about 5% said they were tightening at the end of the previous year.
The quick math reveals that’s a 700% increase in the number of loan officers reporting tighter lending standards.It appears that Jamie Dimon is wrong that “this part” of the crisis is over. But more concerning to me are the “other parts” that are headed our way.To get a better sense for where all this goes, and what investors need to be doing about it right now, join Louis next Tuesday.Have a good evening,Jeff Remsburg
