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THE SLOW TRAIN WRECK CONTINUES

The “big bang” moment for the start of the Great Financial Crisis is often traced to August 2007 when initial problems within two Bear Stearns funds became news. Because residential foreclosures are easier and individually smaller than commercial real estate, the residential mortgage market downturn moved with pace. For those of us managing money at that time, it came with a lot of pace! I remember I was heading to Florida with my wife and kids and our close friends and their two kids. We were at LaGuardia Airport and my friend, Ben, told my wife that he wanted to keep an eye on me because I looked grey. Those were very uncomfortable and fast-moving days!

Fast forward to March 2023 and the destruction of Silicon Valley Bank and a crisis of confidence in other regional banks. While that eventually began to quiet for some time, we have been thinking of the regional banks as a slow-moving train wreck. On April 1st, S&P placed five regional banks on negative watch, and these banks include M&T, Synovus, Trustmark, Valley National, and First Commonwealth.

The problem for the banks is a multifaceted issue. On the one hand, banks have the ability to finance operations with very low-interest expense. Fed Funds rates, however, in excess of 5% make bank funding infinitely more expensive. The onset of COVID and work-from-home created a second major issue because office usage went down significantly, and many tenants have and are still wanting to reduce their footprint. Excess square footage has placed downward pressure on rents and thus the net operating income of many office properties has declined. Many of these properties have been financed by regional banks, and in numerous cases, these commercial mortgages have been held on the books of the regional banks because historically these instruments have provided a significant source of stable income.

This negative issue for regional banks is at odds with the recent strength in the stock market and the GDP reading. While Silicon Valley Bank had a significant level of uninsured deposits, many of these banks are not in the same predicament. The placement of a negative watch does not mean imminent demise, but it does mean they have challenges in front of them given real estate and the continued level of interest rates, particularly at the short end of the curve.

We continue to think that this market calls for reviewing your asset allocation, prudent rebalancing, and not getting caught up in the euphoria of the stock market. The realities of the massive Biden budget with its built-in deficit are of concern and we think the overhang of commercial real estate will take some time to work out. We do not think that the work-from-home scenario is going to change anytime soon. Ask an adult to come to the office and boy will you see a reversion to a six-year-old very quickly! Also, the level of interest rates is a headwind for the banks, and it may take more time for rates to come back to a palatable level for the regional banks. More to come…

This commentary has been prepared by Knights of Columbus Asset Advisors (“KoCAA”) for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions and information expressed herein reflect our judgment and are subject to change without notice. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities.

KoCAA is an SEC registered investment adviser that maintains a principal place of business in the State of Connecticut. For information about KoCAA’s business operations, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website at adviserinfo.sec.gov. KoCAA is a wholly owned subsidiary of Knights of Columbus, one of the world’s largest Catholic Lay Organizations. Investing involves risk and you may gain or lose money on your investments. For additional information visit KoCAA.com or write to kofcfunds@kofcassetadvisors.org.