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The Trouble Facing Regional Banks

Published March 15, 2023

The following is an aggregation of thoughts on the burgeoning banking crisis, as posted in the Daily Contrarian. Subscribe to receive the briefing and accompanying podcast each market day morning.

Last weekend saw the dramatic rescue of Silicon Valley National Bank (SIVB) and Signature Bank of New York (SBNY). The market reaction was drastic, with investors punishing regional bank stocks and today shifting their focus to European banks. Credit Suisse (CS) dropped to an all-time low after its largest investor ruled out further capital infusions.

Unfortunately, the underlying issue facing banks in the US at least remains unresolved. Banks still hold large amounts of held-to-maturity, or HTM, assets. These are US Treasuries and other government bonds that don’t need to be marked-to-market if they are (you guessed it) held to maturity. The problem is if these assets need to be sold, in which case they do need to be marked-to-market. If that happens it leaves banks with a huge hole in their balance sheets from the ensuing write down. See Silicon Valley Bank, which tried to plug their hole with a capital raise. Didn’t work. This issue of HTMs has been known for some time. Here’s a Wall Street Journal piece from November.

By closing Signature Bank, regulators presumably removed the domino that they believed would be the next to fall. The Fed for its part set up an emergency lending program called the Bank Term Funding Program, or BTFP, to shore up liquidity in the financing system. The question now is how effective these measures will be. There is reason to believe they should be at least somewhat effective, according to our guest on this week’s podcast.

That’s great, but then what about the business viability of these regional banks? If depositors are worried about their money it stands to reason that they will move it to a larger financial institution. How can smaller regional banks compete with these juggernauts, especially if they are faced with larger regulatory burdens as can be expected? At best, their margins will be severely pressured. At worst they will have to deal with a run on their deposits.

The New Narrative, a lot like the Old Narrative

Published February 13, 2023

Concerns about inflation and Fed rate hikes are front and center again as focus turns to January’s CPI print…

The following is an amended version of the Feb. 13 Daily Contrarian. This briefing and accompanying podcast are released to premium subscribers each market day morning by 0700. To subscribe, visit our Substack or Supercast.

It’s a big week with the Consumer Price Index supplying a fresh inflation reading Tuesday.

Last week wasn’t great for stocks. In fact, it was the worst week of the year so far. Inflation was one persistent theme to emerge from earnings, which from the looks of it is getting investors to rethink the narrative that the Fed can start cutting rates later this year.

In reality that narrative was foolish to begin with. More importantly, it wasn’t due to any tangible comments by Fed officials — some off-the-cuff hints by Powell that probably weren’t even intended as such were enough to get investors to pile into risk assets, however temporarily.

So apparently the narrative has shifted again, from ‘soft landing’ to ‘higher for longer.’ From ‘don’t fight the tape’ to ‘don’t fight the Fed.’ Which means this meme can safely be unearthed again:

Reality Check

This latest market activity is a bit of a relief to those of us who were questioning our sanity coming in to last week. Markets can stay irrational for awhile (longer than we can stay solvent, as the saying goes) but maybe this latest bout of bullish irrationality just wasn’t long for this world to begin with.

Two things we’ve been pointing out the whole way: 1) the Fed record of engineering soft landings is not good, and 2) there is a lag effect between when the Fed sets interest rates and when these are felt in the real economy.

This doesn’t make for a particularly constructive environment for risk allocation and makes the January rally look like a dead cat bounce.

Now that that’s settled, we can consider all the ways that it’s wrong. Have at it.

Podcast Excerpt

Quick highlight from today’s podcast (available in its entirety for premium subscribers) courtesy of our YouTube channel:

Cyclical Stocks to Outperform as Inflation Drops to 3.5%: Barry Knapp’s 2023 Outlook (Szn 5, Ep. 1)

Published January 9, 2023

Barry Knapp of Ironsides Macroeconomics rejoins the podcast to discuss his surprisingly sanguine view of the economy in 2023: Why cyclical stocks should outperform the technology and defensive sectors, and why he’s expecting inflation to drop to 3.5% by the second half of the year.

Content Highlights

Inflationary recessions are different from deflationary ones. The last four were the latter. If there is a recession this year, it will be the former (02:18);
Earnings downside is limited in this scenario, by 5% based on what happened in similar situations in the past, and earnings should actually go up (5:56);
Tech margins should continue to be under pressure but economically-sensitive cyclical stocks should see margin expansion (10:50);
The US labor market has actually started to weaken considerably — and not due to Fed policy (12:18);
There have been some big adjustments in the labor market post-pandemic (16:47);
The ‘wealth destruction effect’ from tech stocks selling off is negligible (27:35);
One point of concern: the deficit. This is where the implosion in wealth could affect things (32:59);
The coming budget battle in Congress is worth paying attention to (34:41);
The ‘higher for longer’ Fed interest rate hike thesis has gained traction. What this means for stocks (43:27);
Inflation: Expect 3.5% CPI by mid-year (47:37).