Get Ready for Another Round of Bad News for Banks

As banks are a pillar for commercial real estate lending, their travails become those of investors, owners, and developers. And those problems are racking up.

There was news last week of bank deposits having contracted year-over-year in the first half of 2023. According to S&P Global Market Intelligence, the change was a 4.8% contraction, the first time in keeping records since 1994 that there was any drop at all. Banks large and small were hit.

Now the Wall Street Journal has pointed out that a “surge in interest rates likely worsened unrealized losses on bonds and loans held by U.S. banks in the third quarter, further straining their balance sheets as they face pressure to pay more to keep depositors.”

The interest rates in question aren’t just the general actions on the part of the Federal Reserve, although that is an important part. They include Treasurys and how they’ve grown since pre-pandemic times.

At the beginning of 2019, yields were 2.51% on the 6-month, 2.60% on the 1-year, and 2.66% on the 10-year. When 2021 opened, those were down to 0.09%, 0.10%, and 0.93%. And as of October 2, 2023, 5.58%, 4.49%, and 4.69%.

As the Fed has signaled that rates might remain higher for longer than many thought, or hoped, that has helped support both the Secured Overnight Financing Rate (SOFR) and Treasurys yields, which together affect higher CRE lending costs, whether mortgages, bridge financing, or construction loans.

Banks, too, feel pressure in two ways. One is on the values of assets. Any loans, Treasurys, or mortgage-backed securities that they bought when interest rates were lower will have seen dramatic drops in value, because as yields rise in such properties, prices fall. The only thing that has let them claim the original par value is the held-to-maturity (HTM) accounting treatment for securities. So long as the assets aren’t put out for sale, HTM allows a company to treat them as a long-term asset that will remain in hand until its term, including the collection of interest and principal.

However, accounting doesn’t necessarily hold sway with investors or depositors who recognize that significant portions of what backs the bank is likely not worth what is claimed if there’s any possibility that the bank might need to raise capital. That is what sent depositors flying from Silicon Valley Bank, Signature Bank, and First Republic Bank early this year. The same dynamic might be part of what has happened to bank deposits.

There is one other way that banks feel pressure. When depositors see non-risky higher rates of return outside of banks, they often move their money. Why not?

That’s another dangerous trend for banks, which use customer deposits as a way to balance their books. They must have reserves on hand with the Federal Reserve. One relatively cheap way to do that is to attract consumers, pay them low, if any, interest, and then have the money on hand. As interest rates rise, banks have to start paying depositors more to entice them into not moving their money. That leads to lower earnings and pressure on the institutions.