Regional bank failures create potential risks and opportunities for investors
Bank stocks have come under pressure after the failure of multiple banks in just a few short days. Here’s what happened and how it affects our outlook for the industry moving ahead.
Regional banks have been rocked over the past week as U.S. authorities shut down two banks in just a matter of days, marking the first bank failures since 2020 and some of the largest since the 2008 financial crisis.
Bank run sinks lender to start-ups
On March 9, 2023, a tech-focused lender announced a restructuring of its $21 billion available-for-sale bond portfolio meant to raise cash and shift its balance sheet toward assets with a shorter duration while improving its future earnings. The sale of the securities, concentrated in long-dated bonds, resulted in an estimated $1.8 billion loss.
The company’s management told investors that this restructuring should improve future earnings by $450 million annually by allowing them to reinvest proceeds into higher-rate bonds. Despite this positive guidance, investors declined to participate in the $2.25 billion common and convertible capital raise and customers lost confidence in the bank, which led to a significant sell-off in its shares. By midday on March 10, the Federal Deposit Insurance Corporation (FDIC) closed the bank and released a statement to protect insured depositors.
Crypto winter leads to voluntary liquidation
The second piece of news to cause ripples within the banking community was the voluntary liquidation of a bank that had been a key intermediary in the cryptocurrency industry. The bank had been the primary bank for a recently collapsed crypto exchange that accounted for over 10% of its deposit base. With the crypto exchange’s demise, the bank had been under pressure since last fall.
Additionally, the bank’s role within the crypto industry meant that the broader downturn in crypto had caused the bank to see a sharp drop in deposits from other clients. Pressure from regulators for banks to reduce their crypto exposure also caused a further drawdown on deposits.
In response, the bank made the decision to self-liquidate, returning all money to depositors with any remaining funds to be returned to shareholders; however, there’s significant speculation about what will be left for equity holders given the current volatile environment.
As panic spreads, another bank falls
As the news concerning these bank failures spread, panicked customers at other niche banks began to withdraw their funds. By late Sunday, a New York-based bank had been taken over by regulators, making it the third bank failure in just a matter of days.
This entity had also played a large role in the cryptocurrency industry and acted as one of the largest lenders in the space, amplifying customers’ fears and prompting a run on the bank’s deposits.
The Fed's response so far has been encouraging
In an effort to halt further contagion and quell fears around risks to other banks, the U.S. Federal Reserve (Fed) released a statement on Sunday announcing an emergency lending facility to “help assure banks have the ability to meet the needs of all their depositors.” The creation of the Bank Term Funding Program will allow for loans of up to one year to banks and other eligible depository institutions, allowing them to pledge U.S Treasuries, agency debt, and mortgage-backed securities as collateral. Notably, these assets will be valued at par, reducing the need for banks to sell these securities at a loss.
At the same time, the U.S. Department of the Treasury, the Fed, and FDIC released a joint statement announcing a systemic risk exception for two of the banks, guaranteeing that all depositors at these institutions would be fully protected. The cost for this is to be funded through the Deposit Insurance Fund (DIF), a pool of money that’s funded through quarterly assessments on insured banks. Any losses to the DIF are to be replenished by a special assessment on banks, with no costs to be borne by taxpayers.
The Fed stopped short of creating a broader safety net for other regional banks—something within its power to do. This more definitive response may not ultimately be needed, but its absence will mean the market likely remains volatile in the near term.
Market reaction creates risks and potential opportunities
Although these extraordinary measures show regulators’ concern around the risk of financial contagion, the efforts stopped short of guaranteeing deposits for the banking industry as a whole. In response, bank stock prices continued to be under significant pressure on Monday as investors worked to digest the rapid flow of news.
Some depositors clearly remain unsettled, which could lead to pressure on deposits with balances over $250,000 as they seek stability with banks believed to be safer; however, the steps by the Fed have provided banks with new tools to manage through today’s potential liquidity challenges.
We also feel that the volatility is creating investment opportunities for an industry that’s generally characterized by well-capitalized companies with limited delinquencies and strong balance sheets. The market action is creating dispersion among select bank stocks, with some seeing additional selling pressure and others seeing stabilization.
In our view, many of the issues faced by the now-shuttered banking entities are likely specific to these institutions due to their high concentration in industries that were facing significant funding, regulatory, or legal pressures. Some banking stocks that are coming under pressure today don’t face that same issue, having customer bases that are diversified across many industries, which reduces their liquidity risk. Additionally, we believe that most banks have assets that have benefited from higher interest rates.
Undoubtedly, deposit pricing pressure accelerated in the fourth quarter as the Fed continued to raise rates. We also expect there to be industry consolidation as some competitors are taken out of the market.
Although we can’t say for certain how long investor concerns around regional banks might persist, we believe this spate of volatility may present an opportunity to allocate toward well-capitalized institutions that have rate-hedged portfolios and a diverse deposit base. In our view, banks that can maintain a strong liquidity profile and benefit from the higher rate environment have the potential to generate a strong return on equity.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person.
All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment, or legal advice. Clients and prospects should seek professional advice for their particular situation. Neither Manulife Investment Management, nor any of its affiliates or representatives (collectively Manulife Investment Management) is providing tax, investment, or legal advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Manulife Investment Management shall not assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions, and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
This material has not been reviewed by, and is not registered with, any securities or other regulatory authority, and may, where appropriate, be distributed by Manulife Investment Management and its subsidiaries and affiliates, which includes the John Hancock Investment Management brand.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.