Banks, Bonds, and Beige Book

Episode Summary

Executive Summary: The episode centers on the post-SVB banking turmoil, distinguishing liquidity stress from credit deterioration. Guests argue the banking system is broadly sound, but funding costs are rising, underwriting is tightening modestly, and some sectors—especially office, subprime auto, and lower-tier consumer credit—face growing risk. Recession odds remain elevated for 2024 more than 2023.

Main Topics: Banking crisis: liquidity vs. credit (Priority: 5/5): The group repeatedly separates the immediate problem in banks as liquidity stress (deposit outflows, funding costs, access to cash) from credit risk, which they see as a later-cycle issue rather than the current driver. Systemic health of regional banking (Priority: 5/5): They conclude SVB, Signature, and similar failures were largely idiosyncratic, with the broader banking system still well-capitalized and not facing a generalized run on deposits. Loan market and whole-loan trading conditions (Priority: 4/5): John Tuig explains how whole-loan trading works, why it is slower and more illiquid than bond trading, and how volumes surged when cash was abundant but have cooled as banks hoard liquidity. Underwriting tightening and real economy effects (Priority: 4/5): The Beige Book and bank anecdotes suggest underwriting standards are tightening, but only modestly so far; the anticipated drag on GDP from reduced lending may be smaller than feared. Sector-by-sector credit risk (Priority: 5/5): Office CRE, subprime auto, subprime cards, and lower-income unsecured lending are the weakest areas, while mortgage credit remains strong and multifamily is mixed because of supply and refinancing risk. Fed response, deposits, and moral hazard (Priority: 4/5): The speakers debate the appropriateness of the government backstop and liquidity facilities, with John favoring strong depositor protection and viewing backstops as necessary for confidence. Recession outlook and market signals (Priority: 4/5): The panel sees recession probability as higher in 2024 than in 2023, but notes that bond spreads and equities are not strongly confirming a near-term recession, suggesting policy backstops may be muting market stress.

Key Arguments: The banking stress was primarily a liquidity event, not a credit event; banks failed because deposits fled faster than assets could be sold or funded. Regional and community banks are the most exposed to liquidity pressure because they rely more heavily on deposits and have fewer alternative funding sources. Loan books are still often carried near par even though their market value has fallen with rates; that creates optionality but also pressure to sell at discounts. Underwriting is tightening, but not dramatically enough yet to imply a deep contraction in lending or an immediate severe recession. Credit deterioration is most visible in lower-end consumer segments, while mortgage remains resilient due to locked-in low fixed rates and strong home equity. Commercial real estate risk is concentrated in office; multifamily is more nuanced because new supply can help inflation, but refinancing conditions are getting tougher. The Fed and Treasury backstops improved confidence by assuring depositors and providing liquidity, though this may increase moral hazard. Recession probabilities are elevated over the next 12-18 months, with 2024 seen as more likely than 2023 for a downturn. Market pricing is mixed: yield curve inversion implies recession risk, but credit spreads and equities are not flashing the same warning, possibly because investors expect policy intervention.

Data Points: Expected recession view at Moody's conference: 95 out of 100 attendees - Mark Sandy’s informal survey of risk managers in New York who expected recession in the next 12-18 months Whole-loan trading volume: $15 billion - Raymond James’ loan sales volume last year, across roughly 475 trades Loan trade settlement time: ~45 days - John contrasted loan trades with T+2 bond settlement Bank Term Funding Program usage: $71.8 billion - John’s cited weekly BTFP balance, down from about $79 billion the week before Credit union loan-to-share ratio: 81.4% - Q4 ratio, up from 70.2%, indicating deposits have not kept pace with lending growth Credit union loan-to-share ratio prior year: 70.2% - Prior-year comparison for the Q4 increase Office CMBS delinquency rate: 3.24% - March delinquency rate; the only CMBS segment rising, near pandemic-era highs but still historically low Retail sales year-over-year growth: 2.9% - March retail sales growth, with monthly sales down 1% and the weakest YoY pace since June 2020 Retail sales monthly change: -1.0% - March monthly decline in headline retail sales Beige Book districts with little/no change in activity: 9 of 12 districts - Post-banking-crisis Beige Book assessment of economic activity Districts with slight declines in activity: 3 districts - Philadelphia, Richmond, and Kansas City were identified as softer districts Banking system backstop threshold: $250,000 - Standard FDIC deposit insurance limit discussed in the government response debate Consumer vehicle payments over $1,000/month: 17% - John’s estimate for the share of new vehicles with monthly payments above $1,000 Average student loan payment: $300/month - Average payment expected to resume when repayments restart Multifamily units in pipeline: ~940,000 - Record number of units nearing completion, relevant for rents, inflation, and refinancing risk Mortgage rates: ~6.5% - John referenced current purchase/cash-out mortgage rates versus much lower existing fixed-rate loans Treasury yield curve: 2-year 4.16%, 10-year 3.53% - Mark cited the inversion and its recession implications Yield curve spread: 62 bps - Difference between 2-year and 10-year Treasury yields at the time of discussion Recession probability, 2023: 40%-45% - John and Marissa’s approximate probability estimates for a recession starting in the remaining months of 2023 Recession probability, 2024 conditional on no 2023 recession: 55%-65% - John and Marissa’s approximate probability estimates for 2024 GDP growth drag from banking crisis: 0.3%-0.5% - Mark’s estimate of potential downside to real GDP growth from tighter lending conditions

Pivotal Quotes: "When you yell fire in the theater, Mark, and people start running for the door, and $42 billion starts running for the door, you don't have a whole lot of options." — John Tuig: Describing the SVB deposit run and why liquidity became existential "I think the banking system is pretty sound. We have some issues. We have some liquidity problems right now, but it's not credit." — John Tuig: Summarizing his view that the current stress is concentrated in funding rather than loan losses "I worry about credit coming... I'm seeing into the future that we are going to get more losses, more delinquencies." — Chris Dorides: Chris flags a coming shift from liquidity stress to credit-cycle deterioration

Implications: Near-term recession risk looks contained, but higher funding costs and tighter underwriting should slow credit creation. Banks most exposed to deposits and CRE office loans face the greatest stress, while policymakers’ backstops may cushion the broader economy and delay visible market distress.