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Regional Banking Sector One Year After SVB Collapse - Fears Remain (Weekly Insights 03/12/2024) Thumbnail

Regional Banking Sector One Year After SVB Collapse - Fears Remain (Weekly Insights 03/12/2024)

On March 10, 2023, Silicon Valley Bank (SVB) became the second largest bank failure in U.S. history (behind Washington Mutual in 2008). Its collapse crippled the regional banking sector and we quickly witnessed the downfall of two more banks (i.e. Signature Bank two days later and First Republic in May 2023).

Just to recap, SVB’S failure was attributed to several factors. The Fed’s aggressive tightening cycle resulted in the value of the risk free Treasuries that SVB held to substantially decline. Second, SVB was a major bank for tech start ups. In 2022, the tech sector struggled due to high interest and inflation rates. As these companies continued to tap SVB for deposits, the bank was forced to sell their depressed Treasuries to meet withdrawals. This put the bank’s balance sheet into question, a run on the bank occurred and ultimately the bank failed. This spread to other regional banks and in total, five banks failed in 2023 amounting to nearly $550 billion of assets, the largest ever in American history. In this weekly, we dive deeper into the current state of the regional banking system after a tumultuous year and why we cannot say the regional banks are out of the woods.

  • Current state of the regional banking system:  Since SVB’s collapse the S&P 500 Regional Banking Index has underperformed the larger S&P 500 Diversified Bank Index by over 30%. From the time SVB collapsed to the end of March 2023, small banks in the U.S. lost ~$220 billion worth of deposits. They have not recovered that base with deposits still below pre-SVB levels. Banks (both small and large) have been forced to tighten lending standards due to concern over their balance sheets. While there has been some easing in recent months, lending conditions remain tighter than the historical average.
  • Regional banks may not be out of the woods: Aside from rising interest rates and less lending ability, small and regional banks still face the crisis in the commercial real estate market. According to a report by the National Bureau of Economic Research, the decline in commercial real estate values may result in “$80 to $160 billion in bank losses” and put anywhere “from dozens to more than 300 regional banks at risk of failing.”1 Last week we saw a consortium of investors rescue New York Community Bank after its shares dropped over 70% and got downgraded to junk status. Its exposure to commercial and residential real estate led to its demise. In addition, according to Morgan Stanley, there is ~$1.5 trillion worth of commercial real estate debt that needs to be refinanced before the end of 2025.  

The Bottom Line: 

We believe the biggest risk to regional banks is in their exposure to commercial real estate debt. The enormous amount of debt that needs to be refinanced will need to be refinanced at higher rates. It will also need to be refinanced in a fundamentally weak environment. At the end of 4Q23 U.S. office vacancy rates hit a record high (~20%), surpassing some of the weakest times in commercial real estate’s history (1986 and 1991).2 Unfortunately banks, due to the nature of their business (deposits are their lifeline), can see their solvency evaporate in a matter of days when negative news sparks a run on the bank. It is nearly impossible to predict and even harder to control. We think we could see more consolidation/mergers in this space as we work our way through the enormous amount of debt that needs to be refinanced.  

© 2023 Authored by Megan Horneman, Chief Investment Officer, Verdence Capital Advisors, LLC.   Reproduction without permission is not permitted. The indexes presented are unmanaged portfolios of specified securities and do not reflect any initial or ongoing expenses nor can it be invested in directly. An investment’s portfolio may differ significantly from the securities in the index.
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