Monitoring the banking system over the past two months has been like watching a slow-moving train wreck. March opened with the collapse of both Silicon Valley Bank and Signature Bank (SBNY) . Soon thereafter, Credit Suisse was betrothed to arch-rival UBS Group (UBS) in only what could be described as a shotgun wedding. That got us through the rest of March and most of April.
This week started with First Republic Bank (FRC) heading into the hands of the FDIC which promptly sold off most of its carcass to JP Morgan (JPM) at a nice discount. This prompted Jamie Dimon to opine that this marks the end of the regional banking crisis, a statement whose validity had the half-life of a mouse fart in hindsight.
Yesterday, TD Bank Group (TD) called off its planned merger with First Horizon (FHN) , which tanked the shares of this regional bank by a third in trading Thursday. PacWest Bancorp (PACW) continued its freefall by being chopped in half during trading action yesterday as the bank announced it was 'reviewing strategic alternatives'. The equity is now down nearly 90% from where it began March. Western Alliance Bancorp (WAL) which looks like it is in the same boat, dropped nearly 40% yesterday.
Given all the events across the financial system over the past couple of months, the major indexes have held up quite well to this point. We have had better than expected first quarter earnings reports for the most part this earnings season, which has buoyed sentiment. The jobs market also remains strong, buttressed by much better-than-expected numbers from the ADP Report on Wednesday as well as the BLS report this morning. However, one should remember that job growth is always a lagging indicator.
Unfortunately, unless the regional banking system stabilizes and quick, it is hard to see how the pullback in lending doesn't cause a credit crunch in the coming months and quarters. It might already be too late for that. As the Chief Economist at Goldman Sachs noted the other day, "Banks with less than $250 billion of assets account for roughly 50% of US commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending, and 45% of consumer lending".
With deposits moving both to larger brethren as well as money market funds and Treasury bills, that pay much higher yields, the regional banking system will have significantly less money for loans and will ratchet up credit standards in response.
This is not necessarily unique to the United States either. In April, the net tightening in credit standards in Europe remained at the highest level since the euro area sovereign debt crisis in 2011. ING just noted that "The recent banking stresses are going to tighten lending standards markedly and that will act as a major brake on economic activity, significantly reducing the need for any further interest rate increases" which applies not only to Europe but also here at home.
Looking historically, when credit standards tighten noticeably, economic contraction and rising unemployment soon follow. With credit harder to find, small businesses will be forced to cut costs and almost every firm will pay higher rates with more stringent conditions on the debt they need to roll over. Hardly a bullish backdrop for stocks and a key reason I remain extremely cautious on the outlook for equities and the markets in the month ahead.
'Credit Crunch' is likely a phrase that gets much more airtime in the financial press throughout the rest of 2023. Investors should prepare accordingly.