June 7, 2023 | Stamford, CT — Although the U.S. banking industry has, at least until now, avoided a much-feared run on small banks, steady deposit outflows are increasing funding costs for banks of all sizes and driving up the price of commercial loans. 

U.S. banks are struggling to maintain and attract deposits in the face of rapidly rising interest rates. This dynamic is increasing commercial banks’ liquidity premium or internal funding costs. According to the latest Greenwich Commercial Lending Market Insight from Coalition Greenwich, the resulting pressure on bank profitability is beginning to effect lending decisions. 

“Higher liquidity premiums are forcing banks to rationalize their limited and increasingly valuable capital, and in many cases to re-think soon-to-close loans already in their pipelines,” says Gregory Schneider, Director, Greenwich Commercial Loan Analytics at Coalition Greenwich.

No Run on Smaller Banks, But a Steady Drop in Bank Deposits Overall
U.S. bank deposits declined by 3.2% in the first four months of 2023. The primary catalyst for this drop was the dramatic increase in interest rates triggered by repeated, aggressive tightening by the U.S. Federal Reserve. Deposit outflows accelerated sharply in March 2023 with the collapse of Silicon Valley Bank and in the immediate aftermath, customers fearing a contagion effect pulled deposits from small banks. 

“Despite fears that fleeing depositors would trigger a crisis among all small banks, the rotation of deposits from small banks to large banks dissipated quickly in the next week, with outflows slowing among small banks and inflows actually reversing to declines for large banks,” explains Gregory Schneider.

Commercial Real Estate Loans Represent Nearly 30% of Small Bank Assets
Small U.S. banks seem to have at least temporarily regained their footing after the rapid downfall of Silicon Valley Bank and First Republic Bank. However, analysts evaluating the strength of small banks are keeping a close eye on the commercial real estate (CRE) market. 

The challenges facing CRE, slashed office utilization rates and increased vacancy rates, are taking a heavy toll on asset valuations. Those depressed valuations could cause significant problems as a wave of maturing CRE loans come up for renewal. Small banks are especially vulnerable to trouble in commercial real estate. CRE loans make up 28.7% of assets for small banks, compared with only 6.5% at big banks. Those numbers leave small banks with more than four times the CRE exposure of their larger counterparts. 

Greenwich Commercial Lending Market Insight is a quarterly review of data and analytics from the Greenwich Commercial Loan Analytics team.