Half of the country is experiencing the banking turmoil of 2023 quite differently from the other half.
Three of the four banks that have collapsed so far this year have been in one state: California. Two of them were headquartered about 45 miles apart in San Francisco and Santa Clara.
The other regional banks most watched by investors in 2023 are also clustered near the west coast. Shares of PacWest (PACW), Western Alliance (WAL), Zions (ZION) and HomeStreet (HMST) – midsize lenders based in Beverly Hills, Calif., Phoenix, Salt Lake City and Seattle – are down between 40% and 79% year to date.
“You don’t see that in other parts of the country,” Janney Montgomery Scott analyst Tim Coffey told Yahoo Finance earlier this month.
There is no single reason why the West is under so much pressure. Some of the banks that have failed or come under scrutiny share certain characteristics, including unrealized losses on certain assets or large amounts of uninsured depositors or exposure to certain types of customers. But some don’t.
Certainly panic, contagion and human psychology are also factors, as are the actions of some investors who see the opportunity to benefit from weaker institutions.
Some of these Western banks say their fundamental soundness is being overlooked amid the chaos.
“Exogenous events over the past two months have created a stark disconnect between our stock price and the underlying strength of our bank,” Western Alliance chief financial officer Dale Gibbons told Yahoo Finance. Its stock is down 40% over the year.
HomeStreet CEO Mark Mason told Yahoo Finance that his company’s stock market valuation “is reserved for companies at risk of bankruptcy and we’re just not.” HomeStreet stock closed Friday at $5.72, down 79% year-to-date.
“I don’t think there was just one factor”
The question of why so many banking problems are on one side of the United States was raised during a House hearing earlier this month. Republican Rep. Young Kim, a native of California, asked California’s top banking regulator, Cloey Hewlett, to explain the confluence of failures.
There have been three so far in one state. Silvergate Bank in La Jolla voluntarily dissolved, while Silicon Valley Bank of Santa Clara and First Republic of San Francisco were seized by regulators in what became the third and second largest bank failures on record in the country.
“Why do you think California financial institutions are bearing the brunt of the current distress?” Kim asked Hewlett, commissioner of the California Department of Financial Protection and Innovation.
“I don’t think there was just one factor,” Hewlett said, speaking specifically about Silicon Valley Bank. “Many factors created the perfect storm”, and “once the fear starts, it spreads”.
What some, but not all, Western banks have in common is exposure to the wealth created in Silicon Valley in an era of low interest rates. Some have lent to venture capitalists, tech entrepreneurs or wealthy individuals in California communities where the tech business has thrived.
Some, as a result, amassed piles of deposits too large to be insured by the Federal Deposit Insurance Corporation. They, in turn, also accumulated bonds and loans that fell in value when interest rates rose, creating losses on paper.
Uninsured deposits have become particularly critical for Silicon Valley Bank, a lender to tech startups and entrepreneurs that spooked its clients when it revealed it suffered a real loss on underwater bonds. Many customers who had deposits above the FDIC limit of $250,000 per account withdrew their money immediately; more than $40 billion left the bank in one day.
“If you think about why the West, the predominant aspect is that there was a higher set of banks in this area that have a large proportion of funding from uninsured depositors,” Tomasz Piskorski, professor in finance and real estate at Columbia Business School, Yahoo Finance told Yahoo Finance.
The First Republic was caught in this crossfire. It also had a high percentage of uninsured deposits and catered primarily to wealthy customers by offering jumbo mortgages at low rates. It also at one time had branches on Silicon Valley’s famous Sand Hill Road.
It lost $40 billion in deposits on Monday after Silicon Valley Bank collapsed and more than $100 billion in the weeks that followed. Regulators seized it on May 1 and sold most of its operations to JPMorgan Chase (JPM).
Its top executive said rumors and misconceptions about the bank spread through social media contributed to its downfall. “Everything changed overnight,” First Republic CEO Michael Roffler told House lawmakers earlier this month.
How it’s different from 2008
The last major banking crisis also began with tensions on the West Coast in 2008.
In July of that year, Pasadena, Calif.-based regional bank IndyMac plummeted after a run on its deposits and a troubled Calabasas, Calif.-based mortgage lender called Countrywide sold itself to Bank of America. In September of that year, Seattle’s Washington Mutual became the largest bank failure in US history (and still is).
But there were as many weaknesses on the East Coast as there were on the West, especially on Wall Street. Bear Stearns had to be rescued by JPMorgan Chase, Lehman Brothers declared bankruptcy, and Merrill Lynch had to be rescued by Bank of America.
In subsequent years, as housing problems spread to the rest of the country, more banks failed in Georgia and Florida than in California.
This year, the eastern half of the United States was not completely immune to the turmoil. New York-based Signature Bank became one of the first banks to fall in March.
More banks outside the West could also come under strain. Piskorski and four other professors have identified 186 small U.S. lenders that have large numbers of uninsured depositors and are therefore vulnerable to panics if the panic escalates again.
“They are all over the United States,” he added.
Investors, however, are even more willing to bet that some of the Western institutions will weaken. The regional banks that are currently the target of the shortest bets as a percentage of all stocks are PacWest, Bank of Hawaii, Western Alliance and Zions, according to data from S3 Partners.
PacWest, Western Alliance and Zions all lost deposits in the first quarter, which may explain the extra scrutiny they received. PacWest and Western Alliance also at one time had subprime lending arms, as did Silicon Valley Bank.
All have all worked to turn investor sentiment around. PacWest shares surged last week after announcing asset sales to two different buyers. Western Alliance provided weekly updates on its performance, and its latest was that deposits were up $2 billion since the end of the first quarter.
“Real investors understand that we have a strong balance sheet, quality assets and a diversified deposit base,” said Gibbons, Western Alliance’s chief financial officer. “These fundamentals were true in February and they are true today.”
HomeStreet’s CEO said his strategy is to shrink the bank’s balance sheet, prevent deposit outflows and temporarily suspend fixed-rate lending until interest rates stabilize. Its profits fell 40% in the first quarter.
Like other bank executives, Mason is also asking the Securities and Exchange Commission to suspend the practice of short selling. He said he believed investors were coordinating on social media to drive down the bank’s share price.
“I think a group attack or herd positioning is real. I know that. It’s not just a rumor,” he said. “When stocks are beaten so far, way beyond fundamentals, it’s no longer price discovery. It’s abusive short selling.”
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