The reason so many of us love watching the holiday special It’s a Wonderful Life is the main character, George Bailey. Through George, we learn of the importance of sacrifice and redemption, small-town values, and, yes, the virtues of small banks. In a critical moment in the film, George hopes to prevent a run on his family’s bank, the Bailey Building and Loan. He implores his customers, many of whom are looking to withdraw their deposits, “The money’s not here. Your money’s in Joe’s house… And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others.” It’s a great glimpse into the nature of banking.
Early on in my career, I was asked by a local community bank to serve on its board of advisors. At that time, I believed strongly – as George Bailey did – that community banks can be, and are often, the friends of small business owners. They are the ones who are at the heart of a community providing the financial services that are most needed for that locale. In addition, community banks recognize the need to fund an expansion wing of the local hospital or support youth sports at the local YMCA that may go unrecognized by a larger national bank with headquarters in New York or Los Angeles.
The community bank has been known to be much more relational and understanding – sometimes providing more favorable terms for small business owners, farmers and specialized companies. Representatives from local banks have gotten to know business owners because they have kids in the same school or on the same soccer team, or they attend church together. This relationship provides more than the basic income and balance sheet analysis that large banks only view when deciding whether to extend a loan. A community bank gets to know the business owner on terms beyond the financials, where integrity and financial acumen can be identified and are often overlooked by large institutions.
Recently, these community banks – sometimes referred to as regional banks – have been struggling due to the collapse of California-based Silicon Valley Bank and New York-based Signature Bank this past March. It’s not surprising in this wake that banks are issuing statements to reassure customers their deposits are safe and sound. (We did just the thing with our custodian, Charles Schwab.) We now know that Silicon Valley Bank and Signature Bank were non-traditional banks engaged in non-traditional activities. Silicon Valley Bank primarily served startup and early-stage technology companies, while Signature Bank’s growth was fueled in large part by gains in cryptocurrency. As the market changed within these industries, the lack of risk management triggered rapid declines in these sector-specific business models.
While writing this, another bank was being closely scrutinized. First Republic Bank’s stock lost over half of its value on April 26, 2023 – a day after it reported first-quarter earnings that revealed a greater exodus than anticipated. The bank was exploring “strategic options” following its disclosure that it lost approximately $100 billion in deposits, and many were concerned there were few options left. This week, regulators seized First Republic Bank and struck a deal to sell the bulk of its operations to JPMorgan Chase. This is the second-largest bank collapse in U.S. history.
For the past 12-18 months, we have been saying the banking system is in better shape than it was going into the Great Recession of 2007-2008. This remains true, however, with every situation, there are differing circumstances. This time around we are dealing with inflation that rose to 9% in June 2022 as a result of massive government spending from the perceived need to relieve stress on the economy given COVID lockdowns and supply chain disruptions. As my graduate school professor chided in ECON 101: “too many dollars chasing too few goods results in excessive prices.” Because the country’s main tool for fighting price increases is the Federal Reserve and its monetary policy, the Fed has a mandate to maintain inflation at a level of around 2%.
Raising interest rates is the primary lever the Fed pulls to bring inflation under control, which sets off an economy-cooling chain reaction. Higher interest rates increase the cost of mortgages and company borrowing, which slows business growth and translates into less hiring. As the job market weakens, salary growth constricts, which further tamps down buying. Less shopping allows supply a chance to catch up. This is what we are seeing occur, which resulted in a “crack” in the system and subsequent stress on regional banks. The mortgages and other long-term assets on a bank’s balance sheet have fallen in market value since the Fed began its rate hikes last year, creating concerns that banks would suffer significant losses if forced to sell those assets to raise cash.
Today, the Fed is meeting to determine if it will once again raise interest rates. If they follow market consensus in increasing the rate another quarter percentage point, it will be the tenth rise since March 2022 – and likely the last. In doing so, it is not only slowing the economy to continue reigning in inflation but is also demonstrating confidence in the financial solvency of the overall banking system. Preserving the value regional banks provide their communities is imperative, and in challenging times such as these, it may be important to remember the wise words of George Bailey, “We’ve got to have faith in each other.” Beyond those words, although there are no guarantees, the fact remains that stocks have historically rallied after the Fed finished raising rates. According to an analysis by Goldman Sachs, the S&P 500 averaged a 19% return in the 12 months after interest rates peaked going back to 1982.
In these uncertain times, please reach out with any questions you may have. We appreciate the trust and confidence you place in partnering with us along your financial journey. We consider it a privilege and duty to provide a steady hand during times of uneasiness, remaining focused on reaching your long-term financial goals.