A slew of regional banks of various asset sizes posted earnings this week. Even though many benefitted from a rising interest rate environment, investors were not impressed. The S&P Regional Banks Select Industry Index is at 1, 346.95 today. This is a 34% decline from where it stood on March 8, 2023, right when Silicon Valley Bank announced it was selling $1.25 bn in stock. There are no signs that this index is recovering any time soon. The KBW Nasdaq Regional Banking Index tells the same story.
Deposits at Regional Banks
Unsurprisingly, deposits decreased in the first quarter of 2023 at numerous regional banks. It is important to monitor regional banks’ deposit levels, because unlike globally systemically important banks, regional banks rely much more heavily on deposits to fund themselves. Those banks that lost deposits will have to will have to pay more this quarter to attract deposits. This will increase their interest expenses in a period when interest rates will probably no longer rise as they have in the last twelve months. This could put pressure on regional banks’ net interest margins.
However, it is important to keep deposit movements in context. From the end of 2019 to the end of 2021, deposits at domestic commercial banks rose by more than 35% to about $18 trillion. Covid induced lock downs left individuals and companies with fewer options to spend money. Also, many companies drew on their lines of credit for fear that banks could curtail those lines as they did during the 2007-2009 crisis; companies then used those funds to deposit them at banks. This rise in aggregate deposits was much larger compared to any period in recent history.
Deposits at commercial banks started to decline steadily since April 13, 2022, since individual and corporate depositors have been increasing their spending as well as looking to benefit from rising interest rates by depositing money in money market funds and other instruments. The deposit outflow accelerated from March 8, 2023, when Silicon Valley Bank’s failure seemed imminent, until March 29th. This period weighed heavily on several regional banks. The first week of April, deposits at commercial banks rose slightly. It is still too early to know if this will be a trend.
Increasing Provisions for Credit Losses
Last week’s earning releases by globally systemically important banks Citigroup
C
, JP Morgan, and Wells Fargo
WFC
, as well as PNC Bank, showed that these banks are preparing for an impending recession. They all raised their provisions for credit losses. While these increases put pressure on net earnings, this action represents good risk management considering current economic and market signals.
Regional banks this week also followed suit in preparing for an economic downturn. Bank OZK and Western Alliance, especially, increased their provisions for credit losses dramatically in comparison to the last quarter of 2022. And Ally Financial
ALLY
, Bank OZK, Citizens Bank, Comerica
CMA
, Fifth Third, KeyCorp
KEY
, M&T, PNC, Regions Financial
RF
, Truist, U.S. Bancorp
TBBK
, Western Alliance, and Zions Bancorp
ZION
, all have raised their provisions for credit losses significantly, in comparison to the same quarter in 2022.
Regional banks will continue to be under pressure not only because of the weakening economy, but also because of their concentrations to commercial real estate, as well as to companies that are very leveraged. As I have written extensively, banks have lent excessively to leveraged companies, and over 75% of those loans are covenant lite. Both commercial real estate and leveraged companies will have a hard time refinancing in this rising interest rate environment. Moreover, the Silicon Valley Bank debacle has made underwriters more careful about their credit due diligence. Moreover, the banking turmoil has reminded treasurers at banks that liquidity should always matter.
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