Lessons Learned
We have been through many crises over the years and no two are exactly the same. SVB and Signature banks have fact patterns that are quite different. Neither case had a lot to do with the health of the economy. Perhaps, the slowing of real estate affected the responses at both institutions but they were driven by trying to keep the growth going.
By now, we know that SVB had too many long assets that were subject to price volatility given the Fed actions over time to raise rates. Signature dabbled too much in crypto currencies. There were red flags along the way in both approaches. Yet, the managements decided to stay with the strategies. Crypto has been rallying back from lows but the damage was done.
I have been asked what does all of these mean for municipals. One of the better aspects of bail out engineering is that the payrolls are met and that not everyone at various affected businesses lose their jobs. This approach keeps revenues flowing to states and localities particularly income taxes.
Some individuals and businesses are likely to cut back on their purchases so sales tax receipts will be affected at the margin. We do not see a sharp decrease in sales developing currently.
Property taxes do not reflect the environment as quickly as other taxes. Some of the businesses will either chose to or be forced to dispose of real assets. A forced sale is more likely to establish a new revised valuation for that asset. Eventually, this downward adjustment will be reflected in the assessed valuation of the tax base. However, we know that the timeline is slow for this kind of adjustment.
I have not come across anything to suggest that states and localities had extensive relationships with these two institutions. However, most states and localities do have strong relationships with their respective regional banks. The relationship includes payroll services, compensating balances, and many other kinds of services. From a municipal standpoint, this is why it was so important for Treasury to take quick action. Otherwise, we would be seeing even more shifting of deposits among institutions.
Another aspect that I have discussed in the media is that some of the pension funds of states and localities did have direct investment in SVB and Signature bank equity. For the most part, these investment positions are on the relatively modest side and are manageable. Most pension funds restrict greatly how many assets may be invested in a single name. The losses still hurt and take time to recoup in overall performance.
Most states and localities have relationships with more than one bank. They often use one bank for payroll and other banks for more specialized services. It could turn out that states and localities will diversify their accounts even more but there is a cost to doing so. As we know in the municipal market, issuers are keen on managing costs. It is probably time to develop a renewed interest in managing risks as well.
With rates moving around so much the market environment is decidedly mixed. After a spate of somewhat higher issuance in March, the issuance pipeline has cooled once again. The uncertainty introduced in the markets by the bank crisis forces issuers to think even more carefully about when to tap the market.
Financial factors aside, once again we have witnessed the importance of crime management with the outcome of the recent primary election in Chicago. Managing the homeless crisis in Phoenix has also been front page news of late. Mental health has continued to be emphasized. States and localities that do not direct enough budget towards these matters are more likely to struggle with the outcomes over the long haul. We know that there are no easy answers to these problems but even incremental progress can make a difference.
The federal budget process has begun and it is quite clear that the parties are far apart on the priorities. Social Security and Medicare/Medicaid are off the table but that means that all other discretionary spending will be hotly debated. Defense spending remains an important priority given the instability across the globe. We do not see how many new programs could be launched in this environment. What we would like to see is that for the programs that are already in place that the dollars could be disbursed more quickly. This conviction is especially true when it comes to infrastructure.
We have heard a lot about the relationship between President Biden and Speaker McCarthy. What are anxious to hear about is whether some kind of collaboration may be found. We are approaching the end of March and there has not been progress on raising the debt ceiling. We know that June is the critical timeframe from Treasury’s perspective. We need action on this critical matter or two banks going under will appear to be of a lesser order.
John Hallacy
John Hallacy Consulting LLC
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