The Consequences & Opportunities of Getting to 2% Inflation
The Consequences & Opportunities of Getting to 2% Inflation
BY SETH GLASSER
At the start of 2022 the Federal Reserve acknowledged the rampant inflation that was spiraling out of control. The central bank made a commitment to reducing inflation down to the desired target of 2%. To accomplish this, the Federal Reserve used the only tool at its disposal and raised the cost of debt significantly month over month. Despite their efforts, inflation continued to climb to alarming levels, reaching as high as 9%. They’ve raised the federal funds rate at a historic pace from 0-0.25% to 4.75-5.0% within 12 months. Inflation currently stands at approximately 6%, a significant distance from the Federal Reserve’s target of 2%. The resulting economic instability had a major impact on the banking industry, with two banks collapsing almost overnight, and a third on the brink of failure. The unprecedented speed of these crashes, combined with the ease of moving funds with a quick swipe on your smartphone is a stark contrast to traditional bank runs, where one had to travel to the local vault by horse and buggy!
Jerome Powell has made his messaging very clear – 2% is the goal and nothing will stand in the Fed’s way of accomplishing this mission. Apparently, we must get from six to two so we’re in for more rate hikes. If you doubt this, listen to his speech on March 22nd addressing future hikes; the median projection amongst the Fed board members for the federal funds rates is 5.1% at the end of 2023, 4.3% at the end 2024 and 3.1% at the end of 2025. The last time the federal funds rate was this high was 2008! This means that unless you have a loan origination before 2008 (which you don’t) you will face a renewal at a higher interest rate!
6% doesn’t sound that bad especially when you consider that Argentina just hit 100% inflation. Or that Zimbabwe created a $100 trillion bill. Perhaps living at 6% for a while and waiting to let the dust settle would be prudent. The economic damage likely won’t be seen for some time and much of the inflation data being used can be linked to supply side issues. Supply side disruptions created shortages of goods, and overregulation in housing and energy restrict supply while demand continues to grow. Let’s see the longer term impact of current rates before we bankrupt any more multibillion dollar savings institutions.
To prevent additional bank runs, Janet Yellen announced that the government will provide guarantees for all deposits above the FDIC’s $250,000 limit, but only in cases where the Federal Reserve deems the bank to pose a risk of contagion to the broader financial system. I’m not sure what the implications of that would be but it can’t be good. When banks fail because the government raised rates to combat inflation, and then the same government bails out the bank by paying the bill (printing money), isn’t that the government solving the problem with the problem?
The implosion of Signature Bank was interesting because the public is not aware of the level of involvement and exposure they had in the New York multifamily business. NYCB took over their entire book of business except for the commercial real estate loan portfolio. When the biggest competitor can buy your business for a discount, and they completely pass – that’s telling. This could lead to a potentially very interesting scenario. The FDIC is going to sell the Signature loan portfolio to one or multiple buyers presumably at a considerable discount. If the discount is large enough, the buyer of the loan portfolio will have enough spread to approach the existing borrowers and offer them a steep discount to buy back their own note. Signature Banks’ demise could save thousands of buildings from foreclosure and alleviate massive amounts of distress in the market. This would be a win/win for the borrowers as well as the tenants that live in these distressed buildings.
The shutdown of Signature and near collapse of First Republic dealt a significant blow to the multifamily lending sector, eliminating two major players from the market. With the lending environment being highly uncertain, it is likely that the remaining players in the market will be selective in choosing their borrowers and setting their rates. This window favors banks more than borrowers – adding to the mounting distress of expiring loans. If the Signature loan portfolio is purchased by an existing regional competitor rather than new players to the market, the consolidation favors lenders, not borrowers, and will keep rates and spreads high.
There is $270 billion in commercial mortgages held by banks expiring in 2023 which means that SBNY and FRC could be the canary in the coal mine. 80% of this debt is held by small regional banks. What does this mean for the New York multifamily market? This creates opportunities for new lenders and new buyers to enter the market with a fresh face and a new story to raise debt and equity. The next 90 days will set us up for a huge back half of 2023.
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