Private Wealth

Weekly Research Briefing: Frozen

March 28, 2023

Silicon Valley Bank, Signature Bank and Credit Suisse may have been taken care of, but investors, depositors and the world's central banks remain on edge. As a result, the public credit markets resemble a chunk of Arctic ice with only the U.S. Treasury able to sell debt in this environment. Even the biggest corporate issuers are on pause and will remain so until drips of water begin to slide down the ice cube. This is not ideal for a fully functioning economy because companies always need to refinance debt and insurance companies need to liability match their insured assets with new debt buying. With SVB in the rear-view mirror and the acquiring stocks of FCNCA, UBS and NYCB reacting positively, there is optimism that the freeze will warm, and the credit and lending markets will begin to reopen. But nothing will be normal until the typical flood of March corporate debt issuance returns.

The FOMC met last week to raise interest rates another 25 basis points. But given how Powell started the press conference with a discussion on the banking industry – that tells you everything you need to know about what is top of mind. The Fed fully expects the failures of SVB, Signature and Credit Suisse to put a pause in the global lending markets, but they have no certainty on the scale of slowdown that will occur. So, expect them to go into a holding pattern on future rate increases until they have more evidence and data. If fewer bank deposits and more regulation leads to less lending, then the economy should slow leading to increased credit stress. Odds of a recession will continue to rise, and it is more likely that future earnings expectations will need to be reduced. If an economic slowdown does accelerate, then inflation worries should end once and for all. That would be good news.

As investors panic rush into the U.S. Treasury and other international sovereign debt markets, risk-free yields have gone into free fall. While this is good news for future borrowers, it means little if the debt and lending markets are currently frozen shut. But assuming they do once reopen, borrowers will find mortgage rates 1.5% lower and short-term borrowing yields nearly 2.5% lower. This could be substantially stimulative to the economy if the banks and credit markets want to lend. As the S&P 500 Index refuses to budge from the 4,000 index level, this new lower rate stimulus could be a major reason. There is also the consensus that the Fed just made its last rate hike for this cycle which has caused some stock investors to begin to position for being longer equities if the Fed's next move is a cut in rates. There is so much uncertainty right now and investors have more questions than answers. It will take many company datapoints and economic data releases before we know how this shakes out. Until then, the increase in market volatility will create much opportunity for disciplined investors to buy equity and debt in quality companies that will make it through the current uncertain economic environment.

One small SVB depositor survey last week showed that in times of stress, customers run to the biggest and safest...


The meltdown in Deutsche Bank's stock price late last week was a bit concerning...

Especially given that DB is nothing like Credit Suisse in terms of profitability or in depositor base make up. Not to mention that the government of Germany will likely always have its hand on DB's shoulder. But the 3 day 30% sell off in DB stock shows you how on edge the current market is.


The Fed raised rates last week, but began to dial back on many of their forward levers...

The FOMC raised the target range for the federal funds rate by 0.25pp to 4.75-5%. The post-meeting statement noted that, while the “banking system is sound and resilient,” the recent banking stress is likely to “weigh on economic activity, hiring, and inflation." The FOMC removed the reference to “ongoing” hikes in the post-meeting statement and noted instead that “additional policy firming may be appropriate.” The Committee reiterated that it “remains highly attentive to inflation risks.” The median dot in the Summary of Economic Projections shows a funds rate of 5.125% at end-2023, unchanged from the December projections. The median projection in the SEP showed lower GDP growth and somewhat higher core inflation in 2023 and 2024.

Goldman Sachs

Starting the press conference with comments about the banking industry tells you everything you need to know...

For the first time in a year the Federal Reserve has left its next policy step in doubt as officials weigh the risks of continued high inflation against a possibly looming U.S. credit crunch that could slow the economy in sharp and potentially unexpected ways.

Walking a narrow line that could leave financial markets both unsettled and guessing about what's next, Fed Chair Jerome Powell said in a news conference that U.S. central bank officials will themselves be in the dark until more is known about how banks might change their lending behavior in response to the failure of two regional lenders caught out by unexpected deposit runs…

"It's really ... a question of not knowing at this point," Powell told reporters after the meeting. "How significant will this credit tightening be, and how sustainable? ... This is 12 days ago," that a pair of bank failures reshaped the financial landscape facing the central bank, with potential implications for the real economy and the path of inflation.


The Fed did consider skipping the March rate hike according to the WSJ's Fed whisperer...

The Federal Reserve approved another quarter-percentage-point interest-rate increase but signaled that banking-system turmoil might end its rate-rise campaign sooner than seemed likely two weeks ago. The decision Wednesday marked the Fed's ninth consecutive rate increase aimed at battling inflation over the past year. It will bring its benchmark federal-funds rate to a range between 4.75% and 5%, the highest level since September 2007.

Fed Chair Jerome Powell said officials had considered skipping a rate hike after banking stress intensified last week. And he hinted that Wednesday's increase could be their last one for now depending on the extent of any lending pullback that follows a bank run earlier this month. Regulators shuttered Silicon Valley Bank and a second institution, Signature Bank, two weeks ago, and bailed out uninsured depositors to stave off a panic.

Estimates of just how much any credit contraction could reduce hiring, economic activity and inflation were "rule-of-thumb guesswork, almost, at this point. But we think it's potentially quite real, and that argues for being alert as we go forward," Mr. Powell said at a news conference after the Fed's policy meeting. Later, he said, "it could easily have a significant macroeconomic effect."


The Fed's shift in rate hikes could make for a future headwind to the U.S. Dollar...

Chairman Powell made it very clear that the FOMC’s framework has shifted. Their baseline assumption is now that the banking system stress has acted as at least the equivalent of a rate hike, and probably more than that. Their new disposition is to be cautious on further hikes unless and until they see evidence that economic drags will be minimal.

U.S. Dollar weakness is likely to resume for several reasons. There are several forces at work. First, the collateral backstop put in place after the SVB bankruptcy is a form of easing, we believe, even though Powell said it is not intended to alter the stance of monetary policy. Second, the Fed’s shift to “some additional tightening” from “ongoing rate increases”, is a dovish statement for the ultimate path of U.S. short-term interest rates. A weaker USD should be a tailwind for global risk assets, as well as U.S. exports, which are currently running 21% below trend.


The Minneapolis Fed Governor hit the Sunday talk shows to reiterate the current uncertain outlook...

Federal Reserve Bank of Minneapolis President Neel Kashkari said recent bank turmoil has increased the risk of a US recession but that it was too soon to judge what it means for the economy and monetary policy.

Asked on Sunday during an interview on CBS’s “Face the Nation” if the strains could tip the country into a recession, he said, “It definitely brings us closer.”

“What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. Would that slow down the economy? This is something that we’re monitoring very, very closely,” said Kashkari, a voter on monetary policy this year. “It’s too soon to make any forecast about the next interest rate meeting.”

The next meeting of the policy-setting Federal Open Market Committee is May 2-3.


The bond markets now see the Fed cutting rates by 175 basis points into year end 2024...

CME Group

The safest stores of money have been gathering all of the assets...

The Biggest Picture: the next bubble…money market fund AUM surges above $5.1tn (Chart 2), up >$300bn past 4 weeks; prior 2 surges ’08/’20 coincided with big Fed cuts.
(BofA Global)

BofA Global

The rush of monies into short duration, safe assets has pushed 2-year Treasury yields lower at the fastest rate since 1987...


Meanwhile, the public markets willingness to finance has evaporated...

The capital markets have been on ice since the collapse of Silicon Valley Bank two weeks ago.

No companies with investment-grade credit ratings sold new bonds over the six business days from March 10 through March 17, the first week in March without a new high-grade bond sale since 2013, according to PitchBook LCD. The market for new junk-bond sales has largely stalled this month, and no companies have gone public on the New York Stock Exchange in more than two weeks.

March is typically busy for new corporate debt financings: Companies look to secure financing before the blackout period between the end of the first quarter and the kickoff of earnings season, when they typically refrain from bond sales. Lately, a lack of investor confidence and wild swings in the Treasurys market have kept companies on the sidelines.

Those with the highest ratings have sold $59.9 billion in new bonds this month, compared with March’s five-year average of $179 billion. The riskier corporations that borrow by issuing higher-yielding junk bonds and leveraged loans are finding it even harder to sell new debt. Companies have raised some $5 billion of junk bonds this month versus the five-year average of $24 billion.


And Venture Capital companies have forever lost their easy lender...

With big banks unwilling or unknowing to be able to service start up company borrowing needs, it will be up to direct lenders to fill the void.

"It's just obvious they have zero appetite for talking about venture debt," Mr. Sanders said, referring to a loan in which a venture-backed company's assessed value serves as collateral. SVB provided debt capital on reasonable terms to private technology companies, and had $74 billion in loans to startups, investment firms and other clients as of December.

Many lenders say they are seeing more demand from borrowers since regulators took over SVB. But lenders often aren't ready to serve early-stage companies the way SVB did, and when they do, their loans are likely to be smaller, more expensive and have more stringent terms.

Conditions in debt markets were already growing worse for startups before SVB's collapse, with rising interest rates and increasing risks in the tech market...

Big banks are out of touch with the unique needs of venture-backed startups, Mr. Rosenblatt said. "They have no service layer to support seed and early Series A companies that are doing under $5 million in revenue," he said. "They certainly don't know how to underwrite lines of credit for these companies." Nonbank lenders also aren't likely to offer startups deals as flexible as ones from SVB.

"SVB was dirt cheap," said Sajal Srivastava, co-chief executive and co-founder of TriplePoint Capital, a nonbank lender that competed with SVB for venture-debt clients. "We don't have deposits to subsidize those cheap loans." SVB could lend to earlier-stage borrowers at cheaper rates because it had a lower cost of capital in the form of bank deposits, and it generated higher revenue per borrower with banking products.


A good chart from Apollo showing how new debt and equity issuance has stopped...

High grade debt, high yield debt and new equity issuance all cut to near nothing. M&A deal activity has continued as these were no doubt transactions that have been worked on for months. But now the question becomes, who will be the financier if debt or borrowing is needed.


Lending markets may be frozen, but consumers are still buying new homes...

Homebuilder sentiment has improved for three consecutive months. While it’s not quite back to a neutral level of 50, fears of another backslide have abated. Instead of builders sitting on a glut of unsold homes that they had begun building during the pandemic, last week's housing data showed that the number of single-family homes under construction has fallen to the lowest level since October 2021.

And after bottoming in November, single-family housing starts have picked up a bit — not the surge we saw in mid-2020, but another sign that builders feel like they are in a position to continue building in the current market rather than pulling back even more.

One of the largest homebuilders in the US, Lennar Corp., noted in its earnings call last week that its February cancellation rate “was 14%, much below our normalized cancellation rate.” They also said that base prices have stabilized in all of the markets they operate in.


Another positive comment from KB Home's earnings last week...

@conorsen: $KBH: “Our gross orders improved significantly on a sequential basis, with January's orders increasing 64% relative to December, and February increasing 58% versus January.”

Three monthly increases in new home sales...

@LizAnnSonders: February new home sales +1.1% vs. -3.1% est. & +1.8% prior month (rev down from +7.2%) … third consecutive monthly increase, which hasn’t happened since 2020; median new home price +2.5% year/year to $438,200

Even existing home sales jumped higher last month as supplies run thin and buyers grab lower rates...

*(US) FEB EXISTING HOME SALES: 4.58M V 4.20ME; Y/Y median price turned negative for first time in 131 months Metrics:

  • Median existing home price: $363K, -0.2% y/y
  • Months supply: 2.6 v 2.9 prior
  • Distressed sales: 2% v 1% prior
  • First-time buyers were 27% percent of sales v 31% m/m NAR's Yun: Conscious of changing mortgage rates, home buyers are taking advantage of any rate declines. Moreover, we’re seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs. Inventory levels are still at historic lows. Consequently, multiple offers are returning on a good number of properties.



Another economic building block seeing interest is the Semiconductor segment...

Thanks to more local onshoring of semiconductor facilities as well as a bottoming of the PC cycle.


The economy's biggest area of worry is increasingly turning toward office commercial real estate...

While workers are now finding their way back into the offices, will it happen quickly enough as asset owners need to refinance their next round of debt.


A record amount of commercial real estate debt is coming due this year...

A record amount of commercial mortgages expiring in 2023 is set to test the financial health of small and regional banks already under pressure following the recent failures of Silicon Valley Bank and Signature Bank.

Smaller banks hold around $2.3 trillion in commercial real estate debt, including rental-apartment mortgages, according to an analysis from data firm Trepp Inc. That is almost 80% of commercial mortgages held by all banks.

With the banking industry in turmoil, regulators and analysts are growing increasingly concerned about commercial real estate debt, particularly loans backed by office buildings, according to industry participants. Many skyscrapers, business parks and other office properties have lost value during the pandemic era as their business tenants have adopted new remote and hybrid workplace strategies.

High interest rates also have wreaked havoc with commercial property valuations. Many owners with floating-rate mortgages have to pay much more monthly debt service, cutting into their cash flows. Owners with fixed-rate mortgages will feel the pain of higher rates when they have to refinance.

This year will be critical because about $270 billion in commercial mortgages held by banks are set to expire, according to Trepp—the highest figure on record. Most of these loans are held by banks with less than $250 billion in assets.


And unfortunately, the small banks who lent much of the last CRE wave are now the ones losing their cheap deposit funding...

The commercial real estate market is naturally dependent on leverage, giving banks an instrumental role in facilitating transactions. Through the end of 2022, the amount outstanding of commercial mortgage loans in the US stood at $5.6 trillion. Over half of this stock sits directly on commercial bank balance sheets, with small banks capturing a much larger share than large banks (Exhibit 1). Including mid-sized banks (i.e. banks with less than $250 billion in assets), our economists estimate that the combined share of small and mid-sized banks is 80% of the overall stock of commercial mortgage loans. Excluding the securitized CMBS market, banks originated over 40% of commercial mortgage loans in the first half of 2022.

Goldman Sachs

Goldman Sachs

The market is not blind to the upcoming refinancing difficulties as the public values for CRE loans has been selling off...

@LizAnnSonders: U.S. regional banks account for ~70% of all CRE loans; while S&P 500 Real Estate has lagged its parent index by 7% MTD, Markit CMBX BBB S14 Index (synthetic tradable index referencing basket of 25 CMBS), is -12% MTD

With corporate earnings season just around the corner, get used to the phrase "lower than expected input costs"...

[SON] Raises Q1 $1.30-1.40 v $1.18e (prior $1.15-1.25); Cites lower costs, higher demand - Sonoco anticipates results to be better than previously expected due to improving productivity, lower than expected input costs, and higher demand than forecasted in certain products and end markets.


More on costs, building material dealers have moved from expecting inflation in January to deflation in February across their products...


With the bulk of corporate earnings to hit in April, there has been a surprising number of March quarterly beats to start the new season...

Much of Wall Street is still anticipating earnings estimates to fall as 2023 develops. But that is not happening yet.

The Big Picture:

  • 11 S&P 500 companies have reported results that get classified as 1Q 2023.
  • Despite increased angst over banks, and a slowing economy, we are very surprised to report that these 11 companies have collectively seen their 2Q 2023 EPS estimates rise, on average, by +0.14% after releasing results this month.
  • This is better than last quarter when these same 11 companies had their next quarter EPS estimates fall at a rate of -0.37%.
  • It is still only 11 companies, or 2% of the S&P 500 index, so the sample size is not yet significant.
  • However, it remains a remarkable start given the macro environment.

The Earnings Scout

The newest portfolio manager survey is showing little consensus for a current most crowded trade...

BofA Global

Finally, if you know of anyone considering either buying a timeshare or even using a timeshare exit company to get rid of a timeshare, you had better have them view this 'Last Week Tonight with John Oliver' first...

March 19, 2023: Timeshares
TV-MA | 35 MIN
John Oliver discusses timeshares, how people get into them, why it’s so difficult to get out, and one exciting new business venture.


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