February 2024
They discuss the exposure of small and mid-sized banks to commercial real estate loans. With interest rates on the rise, these banks face increased risk as loans come due and need refinancing. Given the tightening credit guidelines, there is a looming threat of liquidity issues, which could compound the challenges these banks are facing. Especially given the high vacancy rates in office spaces, and the fact that small and mid-sized banks hold nearly 70% of the outstanding loans on commercial real estate, there could be a potential risk to the broader financial system if these loans begin to default, thus re-triggering a regional banking crisis.
Although the markets are hitting new highs, it is extremely important to monitor economic indicators closely, stay updated with new policies, be mindful of FDIC insurance limits, and gain a better understanding of how banks operate, including reserve requirements and liquidity positions
Watch previous episodes of THE FINANCIAL COMMUTE here:
Ep. 71 What a Resilient Investment Portfolio Means to Us
Ep. 70 Different Ways to Access Real Estate: REITs vs. Private Funds
Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by wealth advisor Patrice Bening. Patrice, thank you for joining us.
Thank you for having me, Chris.
Stock markets hitting all-time highs in 2024, most of the headlines around, you know, corporate earnings and technology and chip makers reporting earnings that are causing their stock to sort through the roof. Fears of a recession are pushed out farther into the future. The Fed is potentially not lowering interest rates any time soon, but that's not the full story.
It reminds me a little bit of the other day when I went to go pick up my daughter from school. She was so excited that I came right in the middle of the day, and she came running up to me screaming, Daddy, daddy, daddy. And lo and behold, when I get there, her face is just torn apart. The whole right side of her face is just bright red, bloody, and dirty. And I'm thinking to myself, my gosh, why is she so happy? Why is she so, so excited? And what the heck happened there? Because it wasn't just so much about her excitement to see me. I mean, there's an underlying story that I need to know about her tripping and falling. And so we're going to talk a little bit about the excitement that's going on, but also some underlying risks that we're seeing out there that people should be aware of, right?
Well, that's probably the best analogy and visual that you could possibly trace.
But again, you know, in the headlines and what we're seeing sort of in the markets, the S&P 500 touched an all-time high. Pretty impressive. If you closed your eyes for the last few years and woke up, you might be surprised, but you might not. I don't know. But it's been a little bit of a rollercoaster coming off of 2022 and 2023, with stocks playing more of a seesaw or a volatile trend. There's been nothing but talks about inflation and the Fed raising interest rates, wanting to tighten, you know, controls on the system to tighten and get control over inflation.
But then here we are, in January 2024. The economy in the market is just ignoring all of it. What are your thoughts about that?
I think it's very interesting to see the dynamic of what's happening right now because, like you said, on the outside, it looks like everything's great. Payrolls are holding up jobs. You look to be doing great. So this recession that we've been waiting to come since last year, and I think the Fed in there, when they raised interest rates so aggressively, thought we were going to have a recession, but that there was no impact truly on the economy of the state, as resilient as it is.
So I'm very curious to see if they are planning to cut rates this year. They said three times, or three quarters of a percent. You know, if that's even beat it or if we're going to stay in this particular higher rate environment, whatever they call a neutral rate rate, which was pre-COVID. And we're now at just the higher levels of that.
And if the economy can sustain it, then they might not cut rates this year. I don't know.
Now, I don't know either. I mean, neither one of us has a crystal ball, and we have lost our ability to see the future. Yes, we have. Nor are we rooting for a recession. I mean, we want the economy to stay strong. We want people to have jobs, make more money, and feel safe. But it's just interesting how over the last 15, 16 years we've seen the market go from, you know, just tons of liquidity, forcing interest rates to be low.
They were worried that the economy wasn't going to grow fast enough. So we're going to keep rates at zero, and we're going to keep pumping money into the system. We're a couple of years removed from that now, where basically the Fed has stepped in and said, We've got inflation, which is now a problem. We have to no longer print money, and we've got to start raising interest rates.
The Fed raised interest rates at the fastest pace in history. There were 11 rate hikes.
11 rate hikes between March 2022 and July of last year.
And so, again, there's a lot of boom, doom, and gloom out there that the headlines are saying is disastrous. The market's going to go down, and the economy is going to go into a recession. And it seems like so far the Fed has done a pretty good job navigating this because they've been able to raise rates, fight inflation to a degree, and we have not gone into a recession.
And so there's a lot of liquidity out there. Consumer spending is still doing well, but we're seeing some signs of that cracking a little bit. You saw something with regards to credit card balances that's kind of ticking up. Is that right?
That, and I would say I would see the danger with rates going up. We see it across the board. So consumer debt, and not just that, but the refinance risk rate. So consumers that have to either buy a house or refinance any kind of debt right now are looking at 2 to 3 times the interest rate that was available three years ago. So that is really shrinking the ability of, I would say, even anyone to be able to get more for their buck and reduce cash flow. But kind of taking it to the next level. If you were to think about last year and the bank crisis that happened almost to the date a year ago and where we are today, it's a little bit different landscape because last year banks had a duration problem, right? They were invested in long-term treasuries that have been impacted by the rising interest rate environment. Well, it's shifted now. We're looking at these mid- to mid-sized banks that have commercial real estate loans and whose interest rates are the loans that are due. They have to be refinanced with liquidity as it was, and, you know, as far as the credit guidelines, that was tight to start with.
So that could potentially be a big problem going forward.
Well, interest rates affect a lot of different areas of the market. But, you know, you touched on the banking crisis last year, and I'm surprised by what happened and how resilient our economy was to get through it, although there were some measures that were taken to put it into place to really help with that bank facility that allowed, you know, these troubled banks to use the treasuries that they had as short-term funding. But at New York Community Bancorp, their stock is down almost 50% in three trading days. They were the bank that purchased Signature Bank, which was in the headlines, and they had issues last year. And so, you know, New York Community Bank bought Signature Bank and came with it.
All of the assets and all of the loans were not good. So since then, these troubled loans and these troubled commercial assets are now sort of rearing their ugly heads. And New York Community Bank Corp. is suffering from that. There was a statistic in this article that we were talking about: office vacancy rates are approaching 25%. So 25% of all offices are vacant, and small and midsize banks hold almost 70% of the outstanding loans on commercial real estate. So not every piece of commercial real estate has debt on it, but of the ones that do, 70% of those are held by small and midsize banks. We're not talking about the JPMorgan Chase of the world. Correct. So this regional banking crisis that we lived through last March and thought was potentially in our rearview mirror could cause some issues here. And that's something that we're looking at or that's causing some concerns for us.
And I think to your point, and this is something that was kind of brought to light last year, but I think even for us and where we talk to our clients about, again, bringing awareness about how you or money is titled at the bank, understand FDIC limits on 250,000 per person per Social Security number. If you have an account with two people, the two beneficiaries, you could actually have $1,000,000 because it's the beneficiaries who insure each person for $250.
So if you have a trust, I would say definitely be mindful and careful, especially if you're with a smaller bank, so that you don't experience it like last year.
But no, I'm glad that you mention that because FDIC limits were definitely in the headlines last year. And, you know, as long as the assets that you have at any of these small or medium-sized regional banks are less than that FDIC limit, you should be protected. That's right. Schwab and Fidelity—they're far different than a bank. A bank will lend out $0.90 for every dollar that they take in.
So, technically, you could have a bank run on any institution, including JPMorgan, if enough people woke up one day and said, Hey, I want you to give me my money; JPMorgan doesn't have it necessarily sitting there. So a bank run can happen to anybody. Whereas Schwab and Fidelity are not banks, they're not lending out $0.90 on every dollar that they have in deposits. They're primarily serving as custodians of your assets. Schwab has a small banking arm, but it's far different than some of the stresses that the small and regional banks are probably under. Yeah, what are some things you did in banking for quite some time? What are some things that you think people should be aware of, besides the FDIC insured limits, as they're thinking about the relationship that they have with their banks or even the need to refinance, and what should they be looking at? Anything come to mind?
I think it's definitely a good thing when, as a recovered banker, as I say, I've cherished the relationships I had with my clients. But I think FDIC was the number-one pain point when it came to discussions with clients. Also, I don't understand how your bank truly banks. They need our deposits in order to make loans. So I would say that last year, when Second Valley Bank literally had a run on the money because somebody had just literally issued something on social media, it had nothing to do with the fact that Silicon Valley Bank was truly in trouble. They just had more illiquid assets. So I would say that generated this entire frenzy around people taking all their money out and then leaving Silicon Valley Bank in a really dire spot. So it's the understanding, even how a bank operates. You can ask, you know, you can talk to your banker, and even you get the public information for, I would say, most of the banks out there. Unless you're with a credit union, what's the reserve requirement? You can see the liquidity. But I would say if you're FDIC insured, you should be taken care of on the lending side. Banks care for... they take pride in relationships. So they typically give you better interest rates if you do have, you know, deposits with them. But right now, I would say that a lot of people, as we talk to clients, are on the fence, like, do I buy now or do I wait for rates to drop? I'd say to make a decision that benefits your family based on the current situation, not on something that's out in the future that we have no control over.
Yeah, those are really good points. I mean, one of the key differences between this year and last year, if there is a banking crisis, is that there is no bailout facility in place to help small and mid-sized regional banks use the bad office buildings as collateral for funding to help them get through this crisis. So that's one key difference. Whereas last year there was a banking facility that the Fed put in place, and they said if you add any, you know, treasuries or mortgage-backed securities on your balance sheet, you can use those as collateral to kind of bridge some short-term funding. So it'll be interesting if this stress continues as the Fed steps in. But what's going to be a key factor is whether or not they choose to decrease interest rates in the future. And by how much? Because, you know, banking stress does filter out to become economic strength.
Thank you so much for joining with me. The markets are hitting all-time highs. And as we're getting excited about that and some of the earnings, especially from the technology companies, and the excitement around that, we can't lose sight of the other risks that are going on in the market. But now that interest rates have gone from zero and the baseline rate, call it Treasury, is, you know, four or 5%, we're finding some great opportunities more specific in the fixed income or lending market that are creating attractive returns.
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