The impact of recent bank failures on the property market

The impact of recent bank failures

Economic impact

The banking sector is back in the headlines with the failure of three mid-sized US banks, including Silicon Valley Bank (SVB), the country’s 16th largest, and a significant provider of funding for the tech sector. 

Not only was SVB’s lending highly concentrated in one sector, but it had a significant level of investment in long-term government bonds, the value of which has fallen sharply as a reaction to rapidly rising interest rates. This left SVB facing large potential losses, prompting a run on the bank as concerned customers started to withdraw their cash deposits. 

These US failures were followed by the emergency take-over of Credit Suisse (Switzerland’s second-largest bank) by UBS. Credit Suisse was also far from typical of the banking sector, with long-standing problems including poor profitability and financial scandals. 

Although these banks failed because of their own flawed business models or specific weaknesses (rather than a systemic issue across all banks), their failures are also linked as their weaknesses have been exposed against an environment of rising interest rates and lower growth.

Potential economic impact

In the UK, this comes only six months after the emergency action required to shore up pension funds following the Truss Government’s ‘mini-budget’. It highlights the vulnerability of the UK and other economies to the rapid rise in interest rates and the potential for unintended consequences.

Problems in the banking sector inevitably feed through to the broader economy via reduced debt availability and lower confidence. Economists had been increasing growth forecasts for this year, and the likelihood of a recession this year had been receding. These forecasts could be downgraded again, although other factors such as some modest positive effects on growth from the Budget, and improving consumer confidence could offset this.

Another consequence will be a slowdown or pause (or even reversal) to the path of rising global interest rates – although in the UK we were already close to the peak of the interest rate cycle. Central banks now have a delicate balancing act between fighting inflation and maintaining financial stability.

The risk of a broader banking crisis

Whilst concerning, the current problems in the banking sector are not on the scale of the 2008 Global Financial Crisis. The broader banking sector is now much more tightly regulated than in 2008 to mitigate against risky lending practices. The banks are better capitalised, are regularly stress-tested and have fewer high-risk loans (although the widespread use of online banking means that a bank run can occur much more quickly now than in 2008). That said, the smaller/mid-sized US banks such as SVB are exempted from key aspects of regulation (unlike their European counterparts), a weakness that has now been exposed. 

Central Banks have shown they are prepared to act quickly to reduce the risk from further failures, including insuring all deposits at the failed US institutions and measures to boost the liquidity of the broader banking sector.

However, there is still a risk of further contagion, for example through runs on other mid-size US banks, which continue to experience an outflow of deposits to larger institutions. Shares across the banking sector have fallen markedly.

Impact on the commercial property investment market

The problems within the banking sector will inevitably feed through to the commercial property market.

In the short term, investment decisions may be delayed, and some debt-funded purchases may no longer be viable, as the availability of debt becomes more restricted, with lenders requiring a wider margin to offset increased risk aversion.

Given the recent falls in capital values, we may see more property owners breaching their loan to value covenants, and this could mean greater difficulties in refinancing as banks exercise greater caution.

Investors will also be considering the impact on the occupational market through lower economic growth, lower business confidence and a lower availability of financing for businesses.

However, it is not all bad news, as a lower peak in gilt yields and base rates will increase the gap with property yields, reducing the need for property yields to rise further.

Impact on the tech sector

The tech sector was disproportionately exposed to SBV. Indeed, around half of all venture-backed tech startups in the US worked with SVB. The US government has introduced an emergency rescue package to guarantee all existing SVB customer deposits. 

In the UK, SVB was a small player overall, but had a strong presence in the SME / tech sector. HSBC has now purchased the UK division of SVB, meaning there should be no direct impact on existing UK customers. Meanwhile in the US, another US regional bank, First Citizens BancShares, has now agreed to purchase most of SVB’s loan book.

Whilst existing customers will be protected, tech sector SMEs may now find it more difficult to obtain new financing. Given SVB’s importance to the US market, and greater uncertainty over the future of the bank, the impact in the US could there be more significant. The UK science and tech sector remains exposed to the indirect effects from any slowdown in the US.

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