That Escalated Quickly — March 2023
The Skim:
1) What just happened to the US banking sector?!
2) Spring is here.
3) More listings but fewer new ones…
Last week will go down as a turning point for our economy and banking sector. While the bailout of depositors at Silicon Valley Bank and Signature Bank prevented an immediate financial calamity, it’s impossible to analyze all of the ripple effects coming down the pipeline. Real estate is slow moving and equities seemed to be encouraged by this news, but the two-year US gov’t bond is screaming something very, very different. To give proper context, here are some of the most recent times the US bond market experienced moves as it did over the last week: 2020 when the US went into lockdown, 2008 when Lehman Brothers went under, 2001 when the tech bubble burst, and the crash of 1987…. You get the idea. Additionally, the futures market in which traders can handicap the path of the Federal Reserve did a 180-degree turn and now implies rate CUTS by the end of the year when it was suggesting another 100 bps of increases only a week ago. This note will contain some of my initial thoughts re: SVB and the pending impacts on the housing market.
What Just Happened to the US Banking Sector?
That’s a really good question and one that I’m not qualified to answer in its entirety, although, there are some immediate ramifications for which we need to plan. I will do my best to explain my perspective below and welcome any requests to chat or connect to discuss what’s happening. (My work cell is 847-477-0440 and my email is jfrost@BluePebbleHomes.com — just shoot me a note).
Silicon Valley Bank (SVB) was a financial intermediary with a lot of connections to venture capital and the tech community. SVB had always been willing to go further out on the risk curve versus traditional banks, and this is why they attracted a lot of money from early-stage tech investors. There are tons of instances in which startups were unable to get the financing they needed from traditional banking sources, so they went to SVB. Once these companies were able to get on their feet and the founders sold, SVB further incentivized those founders to keep their cash at the bank in order to receive better terms on personal and business loans going forward. While it might have been a little incestuous (shareholders, depositors, borrowers, etc. were all the same group of people), it still doesn’t seem like they were doing anything super crazy or fraudulent in their model.
Everything changed when the longer-dated bond market sold off this year and depositors simultaneously came to SVB to get their money out. SVB had invested in longer-term bonds like mortgages and 10-year treasuries as a way to generate additional yield against their deposits. SVB was allowed to carry the value of those notes at par (100% value) on their books for regulatory and accounting purposes, so it couldn’t dodge the fact that market values for those securities had gone down by the time they had to sell to fund withdrawal requests. They announced the loss and then the dominos fell — quickly.
The tech community and social media got really spooked about a +$1 billion loss at a bank that everyone thought was extremely safe, so depositors started moving their deposits to other banks and tweeting about it. Social media and modern news outlets carried this worrisome message and the bank run became self-fulfilling once everyone realized they didn’t want to be the last person in line who couldn’t get their money out. What made the bank run worse was that 94% of SVB’s deposits were uninsured by the FDIC, so there truly was a risk of those deposits not being available and this gave even more credibility to the bank run. To give you an idea of the scale, Roku had $487 million deposited at SVB (about 25% of their cash) and they were unsure of how much of that would be lost had the FDIC not intervened.
The FDIC took control of SVB (and Signature Bank) and made the announcement that all the depositors at those banks would be made whole even if there were more losses as the bank wound down — this averted the “end of the world” scenario for which many had feared. Additionally, the Biden administration announced there would be no risk to any deposits in the United States which quelled some initial fears about bank runs at smaller, regional banks where capital ratios and regulations are not as stringent as major money centers (even though there is a logistical problem of making good on this promise). The biggest problem going forward is that the system is not built to guarantee all deposits at every single bank across the United States.
The FDIC acts like a giant insurance company for banks. If you’re in their system, you pay fees (premiums) that go into a fund used to offset losses for depositors whenever a bank fails. Those premiums are calculated based on the gross potential exposure across accounts at the bank which previously had been limited to $250k - $500k per account. Smaller, regional banks were also under less federal scrutiny because they hadn’t been deemed “too big to fail” and were allowed to have different capital structures due to their perceived lack of systemic risk.
That is all different now.
Had the administration not suggested that all deposits, no matter the balances, across all banks in the US were safe, then there would have been an overnight failure of the banking system. Here’s the thought exercise: if the government isn’t going to backstop the regional banks (like Alpine Bank or First Bank — my money hasn’t moved an inch from these banks, btw) but they would Chase or Bank of America, why would there be any reason to keep your money at a smaller bank? There would have been an overnight transfer of billions of dollars from the regionals to the major money centers and there would have been no way to prevent a collapse of the regional banking system.
While staving off those terrible consequences is a good thing, the FDIC’s problem is that their fund is not designed for those broad guarantees. If the government is going to have to now insure against ALL deposits instead of the previous limits per account, then insurance premia have to go up and that will cause a devaluation of regional banks. Additionally, since it’s been deemed that regional banks now pose systemic risks, the federal government will likely require higher capital ratios for those banks going forward. Higher capital ratios mean those regional banks won’t be able to issue as many loans, so the cost of credit for small & medium-sized businesses is about to go up while the availability is going to do down.
The concern about the economic consequences of the last few days is why the bond market is now implying the Fed will have to cut rates by the end of the year instead of continuing to raise them. The bond market is telling us that everything going on had an even greater impact than what the Fed was planning to do over the next six months, and this happened over the course of three days. While the fallout is continuing (read: Credit Suisse), here are a few things that are very likely to happen in the next 6-12 months:
Your deposits at any bank will be safe. It would be a political disaster to let any depositors lose money after SVB, and I don’t think either political party is going to want the blame should another bank fold. Expect regulatory scrutiny to increase at smaller banks and lower profit margins.
The costs of borrowing money will go up. Even though risk-free rates are significantly lower than a week ago, it can be assumed that credit spreads will increase dramatically to offset increased costs & capital ratios at regional banks. Additionally, these banks will be trimming their loan portfolios to ensure that only the best credits are on their books, so bad borrowers are going to be in trouble refinancing. If you are going to need to refinance a loan with a regional bank soon, my suggestion would be to get started on that now.
The costs of getting a real estate loan are probably going up, too. Smaller, regional banks are huge lenders to local real estate developers, and lack of capital + increased costs will make it harder for future projects to get done. The impact will likely be bigger on the commercial side as these loans often stay on a bank’s books vs. sold to Fannie / Freddie, so the commercial real estate market is likely to experience a bit more pain than was already expected.
The residential market will be fine as long as we don’t go into a depression. Since the government has agencies in place to maintain liquidity in the residential mortgage market, residential borrowers are going to see a decrease in mortgage rates as longer-dated bonds react to this news. Without a lot of housing supply coming on the market, the relief in borrowing costs will help buyers and probably cause a pick-up in activity (more on that below). The only way this gets “messy” on the residential side is if there are mass layoffs and the unemployment rate in the US starts to go above 5.0% (right now we’re below 4%). The “messy” scenario is not our base case for the residential market, in fact, it’s looking like the opposite right now.
On that note, let’s get into the real estate stuff!
Spring is Here.
Let’s check in on our trusty table summarizing the residential housing conditions in the Denver metro area:
All data taken from REColorado from March 10-15, 2023. The statistical area is represented by homes within a 10-mile radius of Downtown Denver.
The end of February is typically when the buzz in our market comes back a little bit. Buyers are getting pre-approved to purchase (and we have a VERY, VERY exciting announcement coming about that for our clients in the next few weeks, stay tuned!) and sellers start doing their pre-listing preparation for spring listings. (We’re here to help if you need any advice on what to do before you sell, too!)
The data is showing our market is waking up, and we’re making a call that this spring buying season will be hotter than expected. January started to reverse the declining trend in units that went under contract (Pending) during the month and February followed suit. While still below the levels we saw in 2022, February was “less bad” than what we experienced during the fall and was the second month in a row of “less bad-ness.” Additionally, the Days on Market (DOM) data confirmed this shift as the relative bad-ness was less bad in February vs. January. The average time a home stayed on the market dropped by 13 days from 25 to 12 in the month which represents a material shift. As you can imagine, sellers are a lot less willing to take price reductions if they think it’s only 1-2 weeks before their house is going to sell versus 30-60 days…
For March and likely the rest of spring, the impact of the aforementioned banking SNAFU will lead to a drop in longer-term bond yields and therefore a drop in mortgage rates. For reference, a 50 bps decrease (0.5%) drop in mortgage rates leads to an increase of about 5% in purchasing power. If you combine that with an increase in wages on the order of 5-7%, then buyers this spring will have about 10% more purchasing power than they did last fall. This will cause a more competitive spring market for buyers while supply still dribbles onto the market.
More listings but fewer new ones…
While it’s encouraging for buyers that the market is slower than last spring and there are more homes on the market, it is not encouraging for buyers that supply continues to come onto the market at a slower pace while the rest of the pool is getting increased purchasing power. New listings continue to drop as the market becomes less liquid and that will drive competition for the best homes which will keep prices elevated.
Before this whole banking thing, there was approximately 1-month of supply on the market and the average DOM was 12 at the end of February — this is when mortgage rates were 50 bps higher. Now, with the decrease in rates and automatic increase in purchasing power, it can be assumed that these conditions will continue to tip more toward sellers.
We are really starting to see the impacts of the end of COVID / remote work as well as the increase in borrowing costs which is keeping people in their homes. We believe this will be a structural shift in the market for a long-time and are making preparations to help our clients navigate this new market. Keep an eye on your email over the next few weeks, and we’re going to help you save a bunch of money (whether you’re buying or selling) with a cool new product offering.
