This past weekend, banks saw their second and third largest collapse, respectively, as regulators closed Silicon Valley Bank (SVB Financial Group, ticker: SIVB) on Friday, March 10 and then closed Signature Bank (ticker: SBNY) on Sunday, March 12. Just a couple of days before, cryptocurrency-focused bank, Silvergate Bank (Silvergate Capital Corp, ticker: SI) also announced plans to wind down. Contagion spread to other regional banks, larger global banks, financial services, crypto, and the broader equity market. But regional banks were among the hardest hit. The (KRE ) was down 14.4% as of its Tuesday, March 14 closing price from Thursday, March 9. The (IAT ) was down 17.3% during the same time period. But bearish situations often stimulate investor and advisor interest (as explained by other VettaFi colleagues here). This note recaps what happened in the regional banking sector, how these ETFs are exposed to SIVB and SBNY, and what investors and advisors should look for next.
What makes banks different from other sectors?
Hindsight is 20/20 and many are wondering why more investors and regulators did not foresee issues with SIVB (maybe the most notable exception was this series of posts on Twitter). Red flags related to its collapse include a wide asset/liability liquidity mismatch, unrealized losses from held-to-maturity securities, and a high concentration of deposits from tech and biotech startups.
The truth is that banking stocks are difficult to analyze, particularly if you are a generalist investor or advisor. Typically, companies will sell a product or service at specified price. Units sold multiplied by price sold equals gross revenue—which is relatively easy to understand. Commercial banks, however, earn money through interest income from assets (loans and investments). Interest income is countered by interest expense from liabilities which includes interest paid on customer deposits and borrowed funds. The bank benefits when they can appropriately arbitrage the interest rates between its assets and liabilities.
The balance sheet also tends to hold more weight as it details the specific assets and liabilities held by the bank. There are also financial strength ratios, some of which are specific to the banking sector, which may be unfamiliar or difficult to understand for investors like the CET1 ratio. The difference between various assets and their accounting rules can also be easily overlooked. For example, many investors probably don’t know the difference in held-to-maturity securities versus available-for-sale securities, which was one of the main red flags behind SIVB’s collapse.
What is happening with regional bank stocks and regional bank ETFs?
Earlier this week, stock trading was halted on both SIVB and SBNY along with several other regional banks due to volatility. SIVB and SBNY were only a small portion of most funds as of March 9 and were priced at zero after closure this weekend. For KRE, which is equal weighted, SIVB was only 1.0% and SBNY was only 1.6% of its total ETF weight on March 9. For IAT, which is market-cap weighted, SIVB was only 1.4% and SBNY was only 1.3% (see more details in this iShares release here). But while trading has resumed on regional bank peers, these have also been trading down significantly on sentiment. From the market close on March 9 to the market close on March 14, several regional banks had stock prices fall significantly, particularly First Republic Bank (FRC), which fell 58.7% and Western Alliance Bancorporation (WAL), which fell 52.1%. KRE has a 0.8% weight to FRC and a 1.2% weight to WAL. IAT has a 1.9% weight to FRC and a 0.9% weight to WAL.
It seems, however, that much of the downturn for industry peers has been based on sentiment rather than fundamentals. WAL released a mid-quarter update on March 10, which attempted to clarify its financial position in light of industry news and some of the recent attention to SIVB’s red flags. At WAL, tech and life sciences deposits are only about 15% of total deposits and flat QTD. Held-to-maturity securities were less than 2% of total assets.
What happens next?
Regulations and government action are key. Some confidence has returned after regulators declared that deposits will be safeguarded, including those above the $250,000 insurance limit in order to prevent more widespread contagion. But that confidence was easily stirred when Credit Suisse (CS) admitted it identified “material weaknesses” in its financial reporting and its largest shareholder Saudi National Bank said that it would not be able to provide any more financial support. From March 9 to intraday March 15, Credit Suisse was down almost 24%, dragging down the rest of the financial sector which was beginning to see some recovery. Unlike SIVB or SBNY, CS is considered a “systemically important bank,” which means that a failure could trigger a financial crisis and is therefore subject to stricter regulations.
Volatility in financial stocks continues — especially with the latest news from Credit Suisse — but regional bank ETFs like KRE and IAT are seeing more interest as some investors are taking advantage of lower prices and waiting for an entry point — particularly when volatility cools and if government regulations are able to quell financial sector fears sooner than later.
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