2023-03-29 14:21:13 ET
Summary
- The United States has large banks and small banks.
- Large banks and small banks are very different, particularly after 2008.
- Large banks have a safe mix of assets.
- Small banks have very worrying exposure to commercial real estate.
- Small banks are under stress, and these institutions drive credit to the private economy.
The Silicon Valley Bank failure brought the health of the US banking sector into question.
Large and small banks are very different in the US, especially after the 2008 crisis.
This article looks at some of the differences between large and small banks and the problem that appears on small bank balance sheets.
Small Banks vs. Large Banks
Large banks in the United States hold 38% cash and securities as a percentage of total assets.
This roughly translates to reserve balances at the Fed, Treasuries, and MBS.
Small banks only hold 29% cash and securities as a percentage of total assets.
Federal Reserve
At large US banks, loans make up 51% of total assets.
Small banks have 65% loans as a percentage of total assets.
So small banks have a lot of loans, and large banks have a lot of cash, Treasury bonds, and MBS.
Federal Reserve
Both large and small banks have been facing deposit outflows.
This has been more abrupt for small banks after the Silicon Valley Bank fallout.
Federal Reserve
At small US banks, loans make up 65% of assets. Of that loan portfolio, real estate is 65%, meaning a lot of real estate exposure.
Federal Reserve
Within that real estate loan portfolio, almost 70% was commercial real estate lending.
So small banks have a high concentration of commercial real estate loans.
Federal Reserve
Within the commercial real estate category, the highest concentration is "non-residential property," which can include office buildings, retail stores, and data centers.
Large banks in the United States don't have much real estate exposure. Only 37% of large bank assets are real estate loans.
Federal Reserve
Large banks have low exposure to real estate as a percentage of assets.
The real estate lending the large banks do is mostly residential. The exposure to commercial lending is very low.
For example, non-residential commercial property lending is only 21% of the large bank real estate loan portfolio, compared to 41% at small banks.
Federal Reserve
Before the 2008 crisis, large US banks did a lot of lending. The loan-to-deposit ratio for large banks was always higher than for small banks.
After the 2008 crisis and regulations hit the big banks, there was a flip, and now the loan-to-deposit ratio is higher for small banks.
Federal Reserve
If deposits continue to flee small banks, even if they stay within the banking system and flow to larger banks, there will be a very significant tightening of credit to certain sectors of the economy, like commercial real estate, that is too risky for the big banks.
The Office Problem
So large US banks appear relatively safe, with 65% of assets held in reserves, Treasuries, MBS, and residential real estate.
Small banks have a high exposure to commercial real estate, specifically non-residential property, which can include highly troubled office buildings.
Federal Reserve
The vacancy rate for US office buildings has surged over 17% nationwide after the pandemic.
WSJ
Some cities, like San Francisco, have office vacancy rates that are near 30%.
CBRE
Data from Goldman Sachs provides some additional clues about the non-residential property loans on bank balance sheets and how much of it is in office buildings.
Goldman Sachs, RCA
So small banks have a potentially large problem. Deposits are starting to leave after the SVB crisis in search of more safety, but also in search of higher yields on safe assets like Treasury bills.
Deposit outflows will make it hard for small banks to grow lending and may cause a deleveraging.
If deposit outflows are severe, deleveraging will cause banks to sell securities or loans.
Securities can be pledged at the Fed for a relatively high-interest rate. This keeps a bank solvent but at a material hit to earnings.
The loan portfolio is a much bigger problem because the value of these potentially permanently impaired assets will be called into question.
Remember that small banks are light in cash and securities and heavy in loans, so the Fed facility is not as helpful to small banks as it is to big banks with a much higher percentage of assets in securities.
Summary
There are major differences between large and small US banks.
Large banks hold a lot of reserves, Treasuries, MBS, and residential real estate loans. The asset mix at large banks is very conservative.
Small banks have most of their assets in loans, with commercial real estate holding the highest weight.
Small banks appear to have outsized exposure to highly impaired office buildings which could generate significant losses.
It will be critical to monitor lending standards and availability at small banks because, in the post-2008 cycle, small banks are the lifeblood of credit to the private economy.
For further details see:
U.S. Banking System: Strengths And Weaknesses