The liquidity crisis facing some small, midsize and regional banks could take years to resolve, leading to further upheaval and consolidation in the banking sector.
Bank liquidity appears to have stabilized in the past few weeks after federal regulators managed to contain the fallout from the
The potential for a long, slow trickle of bank failures and consolidation is made more likely if inflation persists and interest rates keep rising. Adding to the uncertainty is an expected downturn in commercial real estate valuations — especially for office buildings — that could lead to writedowns and other problems. The economic climate is drawing comparisons to the savings and loan crisis when thrifts began failing in 1989.
"We may not be out of the woods yet, if history is to be any guide," said Mark Chorazak, a partner in Shearman & Sterling's financial institutions practice. "There are some historical parallels to the S&L crisis, when high inflation gradually exposed dire mismatches between long-dated fixed-rate assets and deposits that were becoming more costly to pay interest on over time."
As earnings season gets underway this week, analysts are focused on regional banks that are expected to disclose deposit levels and current risk factors in their quarterly securities filings. The disclosures will give a better picture of deposit outflows and banks' narratives around current interest rate and duration risks.
Some banks are "between a rock and a hard place," said Richard Laiderman, co-founder and chairman of StandardC, a San Francisco software fintech, and a former managing director at Promontory Financial Group and former head of global treasury at Visa. Because of accounting rules, banks would have to realize losses if they sell securities.
"The danger is that there are lots of banks around the country that are deeply underwater on their securities and mortgage portfolios, and for them it will be a slow bleed," Laiderman said. "Some of these banks would have been acquired already except the market has been so hot until recently that they've got this inflated view of their valuation. They could get bought now that their valuations are lower, but they still may need assistance. Whatever happens to them going forward will be in slow motion like the S&L crisis, not superfast like Silicon Valley Bank."
A key difference with the S&L crisis is the response from policymakers. When interest rates and inflation rose dramatically in the 1970s, Federal Reserve Chairman Paul Volcker raised interest rates to a peak of 20% in 1981. Thrifts were caught flat footed, losing deposits to money market funds and paying higher rates to attract depositors while earning lower, fixed rates on long-term mortgages. Many thrifts were allowed to try to dig themselves out of a hole that left them with massive credit risk ranging from junk bonds to cattle farms. The Resolution Trust Corporation closed 747 insolvent thrifts over a six-year period that ended in 1995.
"This time around banks that are functionally undercapitalized because of mark-to- market losses on their securities and on their loans will be constrained by regulation from rolling the dice and hoping that everything goes their way," said Brian Graham, partner and co-founder at Klaros Group. "There are a bunch of banks on an economic basis that have less capital than they should have and they're going to have to fix that, and it can happen over time or it can happen rapidly."
Graham said it was not a surprise that the Federal Deposit Insurance Corp. brokered the deal for Silicon Valley Bank's branches and loans to be acquired by the smaller First Citizens BancShares, a $109.3 billion-asset bank in Raleigh, North Carolina.
"It's unlikely, from my point of view, that the government is going to permit the money center banks to buy a bunch of regional banks," Graham said. "I think you'll see some regionals merging with regionals, you'll see some capital raises, and some sales of business units, assets, loans and securities."
Alexandra Barrage, a partner in the financial services group at Davis Wright Tremaine and a former associate director of policy at the Federal Deposit Insurance Corp., thinks it will take several cycles for banks to work through today's challenges, including the extent to which they are losing deposits. Banks that have tapped the Federal Home Loan Banks and Federal Reserve's new liquidity facility or discount window will at some point need to be recapitalized. Those dynamics will play out through 2024 and 2025, she said.
"Consolidation isn't necessarily going to happen in the short term, I think it will take a few cycles," said Barrage. "There's going to be a lot of pressure on banks to raise more capital, which will of course impact earnings. We're going to see some bank consolidation, we're going to see smaller banks merging with others, and that's going to be interesting because there's been so much talk on
Commercial
"We may be facing a rolling wave of interest rate risk transitioning to credit risk, but I'm not sure if the credit risk today is as bad as it was during the S&L crisis," said Rod Dubitsky, a former advisor at the asset management firm Pimco, who started his career as a capital markets analyst at the former Office of Thrift Supervision at the height of the S&L crisis. OTS
"The wildcard here is what happens in commercial real estate," said Graham. "It's one thing to deal with a liquidity crunch, it's quite another to deal with credit losses. It's of concern and how it plays out is going to depend on lots of factors."
Policymakers and analysts are focusing on how commercial real estate holds up on bank balance sheets given the trend toward remote work, layoffs in the tech industry and the scaling back of office space during the pandemic. Commercial landlords grappling with rising vacancies and falling revenue signal trouble ahead.
"If I were a banker, I'd want to go into this period of uncertainty with respect to commercial real estate with a fortress balance sheet and excess capital to be able to be opportunistic, and to bolster all that uncertainty," Graham said. "The interest rate risk has weakened a lot of banks' balance sheets and so those two can stir together, but I would caution that they haven't yet."
