Why analysts say banks will be fine

Banks have been struggling with this lately.

Earlier this month, both Silicon Valley Bank and Signature Bank saw runs on their deposits as customers quickly withdrew billions of dollars that the financial firms didn’t have on hand to pay off. The Federal Deposit Insurance Corporation seized the failing banks and guaranteed all uninsured deposits, but depositors and investors alike remained concerned that more bankruptcies lay ahead.

Shares in First Republic Bank rose nearly 30% in Tuesday trading after Treasury Secretary Janet Yellen said in a speech that financial regulators would be willing to support smaller, regional banks in the same way as SVB and Signature to mitigate the risk of contagious failures. suppress.

It’s hardly a time to celebrate. First Republic is seen as one of the banks most at risk of SVB-style bankruptcy, prompting a group of 11 major banks to lend $30 billion to the struggling institution. The 30% increase in share price comes after a 90% decline.

Where does that leave the banks now? It depends on who you are asking and on whose behalf you are asking.

Most analysts say that what happened before is unlikely to spread to the banking sector and cause a complete collapse. “This is not the financial crisis,” said Alexander Yokum, an equity research analyst at CFRA. “The majority of banks will be fine. All major banks will be fine.”

As for those looking to invest in bank stocks, some see the recent turmoil as a huge opportunity, while others say it might be wise to err on the side of caution. This is why.

What happened at Silicon Valley Bank and Signature Bank could, in theory, happen anywhere if depositors are concerned enough about the safety of their money. As to whether bankruptcies can spread to other banks, “everything in banking can be contagious because it’s all based on trust,” said Ania Aldrich, an investment director at Cambiar Investors.

That confidence has wavered recently, as many medium-sized regional banks have reported deposit outflows. Larger institutions, such as JP Morgan Chase, which are seen as more stable by savers, are seeing money pouring in.

But there is reason to believe that consumers generally won’t lose confidence in the system, experts say. For example, SVB and Signature were outliers in the banking world.

Both banks catered to volatile industries in need of quick cash – tech startups for SVB and crypto-related companies in Signature’s case. More than 89% of domestic deposits at each bank were uninsured, meaning more than the $250,000 the FDIC guarantees. That’s well above the 47% average among U.S. banks with $50 billion or more in assets, according to S&P Global Market Intelligence.

In addition, they both had stocks of government bonds that were worth less than what they paid for them, like many other banks.

All of these factors led to panic among depositors at the banks who feared that the banks would have to take losses on their bond portfolios to meet customers’ cash needs.

“It was really those unique features that led to those problems,” said Nathan Stovall, head of financial institution research at S&P Global Market Intelligence. “It wasn’t so much a fundamental issue as a crisis of confidence.”

Investors have since offered shares of other banks – including First Republic – with profiles similar to SVB and Signature. But swift action by regulators has prevented the contagion of failures from spreading.

Not only did regulators back up the uninsured deposits in the failed banks, but they also created a funding program to provide emergency money to ailing institutions. The Bank Term Funding Program, launched earlier this month, allows banks to borrow money from the Federal Reserve by using their bonds as collateral, meaning a troubled bank doesn’t have to sell them at a loss.

“The banks are fine because the Fed has brought in a bazooka to allay further fears that the institutions are not standing firm,” says Stovall. “And the most [banks] say they don’t need it.”

Investors do not believe that banks – especially regional banks – are totally out of the woods. An exchange-traded fund that tracks regional banks in the S&P 500 is down 33% over the 12 months ended Tuesday.

For some investors, a drop of that magnitude is an excellent time to buy. “We believe this is one of the best risk-reward trade-offs in this group that we’ve seen in our 23-year career,” analysts from investment firm Baird wrote in a recent note.

“Stocks are cheaper today than they were during the pandemic, and if you don’t buy banks here, we’re not sure when you will,” the note read.

However, depending on your risk appetite, such a gamble can be stomach cramping. Even with low prices, banks still face a litany of risks, Aldrich says.

While the Fed’s funding program is a useful safety net for banks, it’s also a loan that must be repaid, which could erode the profitability of any affected bank, she says. And given recent events, banks are likely to become more reluctant to lend and may even become subject to new regulations.

That also entails the risk that savers will panic and cause banks to falter further, which is still possible.

“There’s too much uncertainty to make an investment case where all the risks are priced in,” says Aldrich. If you’re considering buying a bank stock because it trades cheaply compared to the value measures of companies in this environment, “that’s tantamount to gambling,” she says.

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