ISA Briefing: Banks, rates and the impact on property

Silicon Valley Bank (SVB) and Signature Bank failed. Regulators
hastily arranged the sale of Credit Suisse to UBS. Concerns
spread about numerous other small and major global banks
including Deutsche Bank. Recent events have raised fears that the
global economy is in for a credit crunch of unknown magnitude and
duration. As we release our first LaSalle Macro
Quarterly (LMQ), a revamp of our long-standing “macro
indicators deck,” banking sector strains represent the number one
macro risk we are assessing. 


The proximate cause of each recent bank failure was deposit
flight, a drain from the liabilities side of the bank balance
sheet. This is fundamentally not a toxic assets problem of the
sort that banks faced in the Global Financial Crisis (GFC).
Rather, it is a liquidity issue that can be addressed by
temporary emergency funding from central banks. But solvency, the
greater concern for banks in the longer run is closely tied to
the duration of the asset book. 


When investors in interest rate-sensitive assets refer to
duration, they typically mean the change in value associated with
a change in risk-free rates. SVB failed, in large part, due to a
perception that it had sustained severe losses on riskless (but
long-duration) US Treasuries and near-riskless agency
mortgage-backed securities as these assets had mechanically
repriced in the higher interest rate environment. 


Just as there was a mechanical element to the initiation of this
crisis, there is a mechanical feedback loop that can help the
crisis partially self-resolve. As worries around bank solvency,
credit conditions and the real economy spread, expectations for
policy rates fell, causing long-duration assets to once more
increase in price, shoring up balance sheets. 


As a result, there has been a 360-degree round trip in interest
rate forward curves between the beginning of February and the end
of March. At first, curves shifted upward due to spiking
inflation data, before falling substantially as banking systems
came under pressure, followed by a return to the status quo as
resolution measures stabilized markets and inflation seized the
attention of policymakers and investors once again. As a result
of this volatility in rate expectations, the MOVE index of bond
option volatility has reached the highest levels since the
GFC. 


There are many media, economic and financial industry sources to
turn to for a deeper discussion of the underpinnings of the
recent financial sector instability, or to track the daily news
flow and the resulting volatility. Our focus is on the practical
considerations for investors in property. We have identified four
key recommendations for how real estate investors can assess
risks and manage through volatility. 





Contributors:


Brian Klinksiek


Global Head of Research and Strategy


Dominic Silman, PhD


Europe Head of Debt and Value-add Capital Research and Strategy


Zuhaib Butt


Director of Investment Risk Strategy and Management