Banks for rich people are different from other banks. They used to have more money.
The latest banking crisis was characterized by subprime borrowers, particularly people with credit problems who obtained mortgages from bankers who ignored the risk that the borrowers would realistically not be able to pay them. Banks that got into trouble were those that made such loans or chewed on them in securitized form.
The current emerging turmoil has so far shown the opposite. Banks like Silicon Valley Bank and Signature Bank that cater to some of the wealthiest, most creditworthy customers — those with super-prime credit scores — are running into the biggest problems.
This is quite a turnaround. After 2008, banking the rich was often touted as a much better model. Even the largest banks began to focus more of their consumer lending and wealth management services on relatively affluent clients, and they cut back on serving subprime clients. Wealthy clients rarely default, they bring a lot of cash and commercial banking and pay high fees for investments and advice, it was thought.
But when interest rates shot up last year, it exposed weaknesses in the strategy. It is not that the wealthy default on loans en masse. But the depositors with the most liquidity with excess cash began withdrawing their cash last year and seeking higher yields from online banks, money funds or government bonds. In addition, startups and other private companies began to burn more money, leading to deposit outflows.
This month, as depositors panicked about bank safety and withdrawals, those with uninsured deposits above the $250,000 Federal Deposit Insurance Corp. limit were most vulnerable. Uninsured deposits accounted for a large portion of deposits with the SVB, prompting customers to keep the majority of their cash with the bank. Wealthy customers came for the perks and then left with their money.
The compound deposit risk is the problem of banks that have many loans and securities that now yield much less than the market rate. Many of these cannot be easily sold if needed to cover deposit outflows. One of the reasons banks piled on securities was because they received a deluge of deposits during the pandemic, but did not see a comparable surge in loan demand. This may have been particularly the case with banks catering to the wealthy, as wealthy customers usually do not need a lot of bank loans for their day-to-day needs.
A major way the wealthy borrow from banks is by purchasing homes, and often in the form of so-called jumbo mortgages. Jumbos are for loan amounts over $726,200 in most places and over $1,089,300 in expensive cities like New York or San Francisco. Jumbo mortgages bring wealthy customers with lots of cash. They also tend to be more difficult to sell to the market, in part because they are not guaranteed by government-sponsored companies like Fannie Mae or Freddie Mac..
So banks are often on it. But the value of these mortgages, many of which have been locked in at low rates for the foreseeable future, has fallen as interest rates have risen.
To be sure, not all banks that target wealthier individual customers are under a lot of pressure. Shares of Morgan Stanley and Goldman Sachs,
are less than half this month from the nearly 30% drop for the KBW Nasdaq Bank index. But those banks are more diversified, focusing more on the more stable, fee-generating parts of the wealth industry, such as stock trading and wealth management, than on mortgages or deposits.
An interest rate cut and liquidity support from the Federal Reserve could calm nerves for now. But the increased pressure on the banking of the wealthy may continue. Deposit movements can further motivate customers to look for the best rates for cash. Some people might refinance if they have mortgages that reset at higher rates, but homeowners with mortgages below 3% aren’t very motivated to move out and take out new loans.
Wealthier customers are also not immune to economic problems. While they will still be better off, events such as corporate layoffs and market downturns will be felt relatively more by white-collar workers than blue-collar workers, who may have a much stronger labor market. This phenomenon is called the ‘wealth’.
Of course, a deep, regular recession and widespread rise in unemployment, accompanied by falling interest rates, may ease the pain. But for now, the problem starts at the top.
Write to Telis Demos at Telis.Demos@wsj.com
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