Bank Failures Could Cause Fed to Pause on Interest Rate Hikes

by Jeff Shaw

It’s an open question whether the Federal Reserve will raise the federal funds rate for a ninth consecutive time when it convenes March 21-22 following the collapse of Silicon Valley Bank and Signature Bank and the downgrade of the U.S. banking system by Moody’s Investors Service.

Citing a “rapidly deteriorating operating environment” despite regulators’ efforts to shore up the industry, Moody’s early this week downgraded the U.S. banking system to negative from stable.

Beth Mace, chief economist and director of outreach for the National Investment Center for Seniors Housing & Care (NIC), says that there is still an outside possibility the Fed will boost the federal funds rate by another 25 basis points at most to combat stubbornly high inflation when it convenes next week. But she increasingly believes the Fed “will hold rates flat until it’s proven that the markets have settled through this banking issue that we’ve seen this week, starting with Silicon Valley Bank last Friday.”

Moody’s on Monday cited the “extremely volatile funding conditions for some U.S. banks exposed to the risk of uninsured deposit outflows” and warned that several banks were under review for possible downgrades, including First Republic, Zions, Western Alliance, Comerica, UMB Financial, and Intrust Financial. Ratings downgrades can make it costlier for companies to borrow money.

“That’s concerning when an organization gets downgraded by one of these rating agencies,” says Mace.

Moody’s anticipates the economy will fall into recession later this year, which would put further pressure on the banking sector.

“I think that [Moody’s] is concerned about the fact that we went from a very low interest rate environment to a pretty high interest rate environment in a short period of time. We saw the fallout of that, of course, with Signature Bank, when it had to mark-to-market its bonds, which caused that loss.”

Ultra-low-interest Treasury bonds that banks invested in just a couple of years ago have sunk in value amid the recent spike in interest rates by the Fed. The Federal Deposit Insurance Corp. (FDIC) has reported that America’s banks are sitting on $620 billion of unrealized losses.

Beth Mace, NIC

Signature reportedly had 40 branches, assets of $110.36 billion and deposits of $88.59 billion at the end of 2022. According to CNBC, Signature customers spooked by the sudden collapse of Silicon Valley Bank withdrew more than $10 billion in deposits last Friday.

Silicon Valley Bank collapsed Friday morning after a run on the bank and a capital crisis led to the second-largest failure of a financial institution in U.S. history. Regulators reported that the withdrawals initiated by depositors and investors amounted to $42 billion on Thursday alone. Silicon Valley Bank mostly served technology workers and startups. California regulators shut down the tech lender last Friday and put it under the control of the FDIC.

Backstop measure

The U.S. Department of the Treasury, FDIC and Federal Reserve announced on Sunday they would waive the FDIC insurance cap of $250,000 and make all of Silicon Valley Bank’s depositors whole. No losses associated with the resolution of Silicon Valley Bank will be borne by taxpayers, according to the agencies.

Regulators also announced they would extend the same systemic risk exception to Signature Bank, a New York-based firm that was closed by state regulators on Sunday amid the Silicon Valley Bank fallout.

“What the federal government has done through the FDIC, the Federal Reserve and the Treasury is to try to take away any type of fears of contagion in the markets. If you look at the stock market today (Tuesday), a lot of those bank stocks that got clobbered yesterday recovered today. What happened over the weekend was a shock to the system, and probably to you and me. The consumer wasn’t anticipating that — and I don’t think the federal government or the Fed was anticipating that. So, I think that might affect the Fed meeting next week. I think it might delay an increase in the federal funds rate,” says Mace.

Practical advice for borrowers

Borrowers want peace of mind. Due to the sudden turbulence in the banking sector, many seniors housing owners and operators are undoubtedly scrutinizing the banks they do business with to ensure the institutions are solvent, explains Mace.

Lending is a relationship business. For that reason, she advises owners and operators to keep conversations going with their individual banks.

“They are your partners, so to speak. You want to make sure they know what’s going on so that they’re not caught by surprise by what you, the operator, is doing.”

Likewise, operators don’t want to be caught off-guard by how the banks are operating, so keeping that dialogue going is paramount.

With banks so highly regulated, the latest market disruption creates opportunities for other debt sources to fill the void. That’s already been happening, says Mace. For example, several equity groups have launched debt funds.

In the current financial environment, it boils down to a combination of risk tolerance and the relationship that exits between the borrower and the lender. “A lot of it comes down to price and terms,” says Mace.

When will the Fed pivot?

Until there is clear evidence that the economy is slowing — and more importantly until inflation is showing signs of easing significantly — Mace says it is likely the Fed will resume boosting the federal funds rate at its May meeting. The federal funds rate currently ranges from 4.5 percent 4.7 percent. That’s the target rate at which commercial banks borrow and lend their excess reserves to each other overnight.

The most recent economic data shows a robust jobs market overall, despite widespread layoffs in certain sectors such as technology. Total nonfarm payroll employment in the United States rose by 311,000 in February, according to the U.S. Bureau of Labor Statistics, surpassing expectations from Dow Jones economists who estimated that the economy would add 225,000 jobs. The unemployment rate rose 20 basis points to 3.6 percent in February, but the rate remains quite low on a historical basis.

Meanwhile, consumer prices rose by 0.4 percent in February and 6 percent on an annual basis, according to the Consumer Price Index (CPI) data released Tuesday by the Labor Department. That’s down from an annual increase of 9.1 percent in June 2022, but still much higher than the 2 percent rate of inflation the Fed seeks to achieve price stability.

“Food prices were up 9.5 percent on a year-over-year basis in February, and energy prices were up 5.2 percent on year-over-year basis. Those are two pretty important expenses for seniors housing,” says Mace.

She explained that while price increases for goods have moderated overall, the cost of services is still rising at a rapid clip. For example, core services were up 7.3 percent in February on an annual basis, and 7.2 percent in January, the fastest pace since 1982.

Workers who don’t get a cost-of-living adjustment in their salaries are finding it difficult to keep up with a 6 percent annual rate of inflation. In effect, their purchasing power continues to decline. “That’s challenging for workers for sure,” says Mace.

The cost of housing in February was 8.1 percent higher than a year ago, according to the Bureau of Labor Statistics.

Soldiering on

Despite the myriad issues that seniors housing owners and operators face today — including high employee turnover, cost of capital issues and significant pressures on net operating income — Mace is bullish on the long-term outlook for the sector.

“You saw that with some of the enthusiasm at the NIC Spring Conference earlier this month in terms of technology and the impact that can have on efficiency. We keep talking about partnerships with healthcare, partnerships with home care, so I think there is a lot of opportunities to grow from that point of view.”

The long-term demographics are also in the industry’s favor. Based on estimates from the U.S Census Bureau, the number of people age 75 and older in the U.S. stood at approximately 23.2 million at the end of 2020, or 7 percent of the nation’s population, according to Fannie Mae. That figure is expected to grow to 34.5 million, or 9.7 percent of the population, by the end of 2030. By 2050, this age cohort is expected to comprise 47.5 million people, and account for over 12 percent of the population.

There have also been plenty of lessons learned stemming from the COVID-19 pandemic, according to Mace, not the least of which is that seniors housing provides a safe and secure environment for the elderly. What’s more, there is a growing recognition that senior living offers a socialization and wellness component that will lead to more growth opportunities for the industry.

But it would be an understatement to say the industry has faced a challenging operating environment in recent years. “We’ve certainly taken our licks, so to speak,” says Mace.

— Matt Valley

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