by Alex Harding, CFA
Vice President, Equity Research
As the first quarter of 2023 wrapped up this week, investors may be surprised to see both stocks and bonds with positive returns, given the ongoing stress within the banking industry and the signs that the Fed’s aggressive interest rate hikes are creating cracks within the economy. So far, the mega-cap growth stocks, which lagged materially in 2022, have been leaders within the S&P 500 index to start the year. Under the hood, things are more nuanced, with less than half of the stocks beating the index. Unsurprisingly, many regional banks find themselves near the bottom of the list as investors fled the industry following the second and third largest bank failures in U.S. history.
Beating out 18 other bidders, First Citizens Bank won the FDIC-organized auction to acquire Silicon Valley Bank (SVB) loans. Headquartered in North Carolina, First Citizens has a history of purchasing failed banks. However, the SVB acquisition will be its largest and more than double its assets to approximately $219 billion, making it a top 15 bank within the United States. On the day of the announcement, the stock soared more than 50% as the market viewed the terms of the deal, including the loss-sharing agreement with the FDIC, as a steal for the bank and its shareholders.
Coincidentally, the day after the SVB sale announcement, federal regulators were testifying to Congress about the collapse of the failed bank. As expected, most of the blame was placed on the firm’s executives and their blatant mismanagement of interest rates and liquidity risk. While undeniably true, regulators may have failed to properly enforce and escalate the deficiencies regarding SVB’s liquidity first identified in late 2021. At the hearing, Michael Barr, the Fed Vice Chair for Supervision, admitted he wasn’t personally aware of the firm’s problems until the middle of February 2023. Senator Jon Tester summarized the situation well: “It looks to me like the regulators knew the problem, and nobody dropped the hammer.” Fortunately, the Fed’s full review of the SVB collapse, including confidential information about the bank, will be released on May 1, allowing the public to assess the situation.
Source: Federal Deposit Insurance Corporation & Goldman Sachs
Regardless of who is to blame for the bank failures this year, we believe the overall banking system is sound and not at risk of financial contagion. That said, the knock-on effect of recent events will negatively impact economic growth as smaller-sized regional banks’ willingness and ability to provide capital to their communities is diminished. The most affected industry appears to be commercial real estate (CRE). According to the Mortgage Bankers Association, U.S. banks make up 38% of the $4.4 trillion of CRE mortgage debt outstanding, with regional banks providing the lion’s share of funding. The tightening of credit standards, higher refinancing costs and sizeable CRE debt maturities over the next two years are causing worry among investors. At this point, the outcome is uncertain, and we caution clients to believe against the “doom and gloom” scenarios spun by the media. We are monitoring the situation closely and started reducing CRE exposure within client portfolios late last year.
Our Takeaways from the Week
Stocks and bonds posted positive returns in the first quarter of 2023
The FDIC-orchestrated sale of SVB loans removes one overhang for the market but recent events will lead to further tightening of credit