03.15.2023 As we approach the one-year anniversary of the Federal Reserve’s first move in its latest rate-hiking cycle, cracks are emerging. Powell & Company, followed by central banks worldwide, ratcheted up the federal funds rate from zero to 4.5 per cent, representing the steepest tightening program in over 40 years. While the situations surrounding Silicon Valley Bank and a handful of other banks were arguably unique to those institutions, the broad banking environment has certainly been challenged under the new rate regime.

After more than a decade of zero overnight rates, banks find themselves competing for deposits in an environment in which market rates have spiked with the fed funds rate.

Big US Banks Interest Bearing Deposit Rates as of December 2022 chart

That suggests that net interest margins, which are already under pressure, will likely continue to narrow as banks catch up.

Net Interest Margin All Banks Chart

A crisis of confidence swept Europe this morning when Credit Suisse (CS) made headlines: Saudi Arabia, the bank’s largest shareholder, disclosed it will no longer continue buying shares. Banking shares fell sharply worldwide. We highlight that the issue surrounding CS is related to earnings, not solvency. However, panicky investors and depositors could turn a profitability problem into a solvency problem in an instant.

Looking at the bigger picture, we’re beginning to see the financial impact of central bank tightening.  Bond investors are signaling to Chairman Powell and his Federal Open Market Committee that they should pause. We agree.

Federal Funds Rate vs 2 Year Treasury Yield chart

This presents an opportunity for private credit, as unregulated lenders fill the void as banks pull back from extending credit.  Keep in mind that the challenges facing banks aren’t credit related, as they were during the financial crisis.  In fact, credit conditions remain robust.  Unfortunately, mass psychology, by its nature, is mercurial.

US delinquency Rates for All Banks percentage chart