VettaFi Voices On: banks in difficulty
It’s not hard to guess what it was all about this week: the regional banking crisis. Today, the VettaFi Voices weighed in on the risk of contagion, what impact it could have on Fed rate policy, and what it all means for the rest of the market and banking ETFs in general.
Todd Rosenbluth, Director of ETF Research: I will defer to Roxanna for Financial ETFs specifically and consider the impact on the wider market. While the SPDR S&P 500 ETF (SPY) was down 2.4% in the week ending Wednesday, the iShares Core S&P Small Cap ETF (IJR) and the iShares Core S&P Mid-Cap ETF (IJH) were down 6.7% and 7.3%. Silicon Valley Bank (SIVB) was part of the S&P 500 Large Cap Index and was not a small or mid cap company.
Investors were selling their high-risk investments and turning to areas considered safe havens, such as the Utilities Select sector SPDR (XLU)up 1.8%, i.e. the Select SPDR Consumer Staples (XLP)up 0.6%.
Were interest rates responsible for the rapid spread? I think so. The Federal Reserve aimed to shake up the US economy with persistent and aggressive rate hikes over the past year, so it was inevitable that some parts of the economy were not as well prepared to withstand the impact. But I expect to see plans for more financial regulation to ensure that something like a bank failure in two days doesn’t happen again so quickly.
Roxanna Islam, Associate Research Director: I just posted a short research note about it: “Regional banks: what to watch out for next.” But there is so much more to say on the subject.
First of all, March was a very difficult month for the financial sector. We’re seeing a bunch of different things happening at the same time, all of which are contributing to this slowdown – which is basically the definition of contagion. Early March, Silvergate Capital (IS) announced its intention to withdraw, followed by the collapse of the two Silicon Valley Bank (SIVB) And Signature Bank NY (SBNY). Now we see problems with Credit Suisse (CS) And Bank of the Financial Republic (FRC)among others.
There are certain structural gaps within the financial sector, particularly with regard to the regulation of regional banks, compared to global “systemically important” banks, such as Credit Suisse, for example. Regional banks are not subject to the same regulatory requirements, stress tests, etc. Many of them are also more “exclusive” in relation to commercial banking activities compared to the big banks, which have non-interest income like investment banking and trading. activity.
Then there have been company-specific issues with a few of the banks – much of which is psychological, including bank runs and recent peer company sell-offs within the regional banking sector. I don’t think it matters how a lot de is psychological, however. The effect on stock prices and investors’ money is real whether the sale is justified or not. Psychological fear may rise or fall over the next few days depending on how government regulators deal with these issues.
Specific to Silicon Valley Bank, the speed at which the bank run happened was accelerated due to social media (especially Twitter). A large portion of this bank’s clients were high-risk venture capitalists, tech start-ups, and more. instead of retail customers. This means that there were several issues at play:
- Lower deposits, given the recent technological environment.
- These customers are usually part of the Fintwit community, Reddit, and other social media forums.
- Many of these customers had deposits >$250,000, which exceeds the FDIC insured limit, so in the event of a bank run, they would be more likely to withdraw funds.
After news broke that Silicon Valley Bank needed to raise more capital, customers began tweeting about the bank’s capital and liquidity issues and withdrawing deposits. Bank runs can be like self-fulfilling prophecies, and there’s virtually no risk in withdrawing your funds and huge risk in leaving your money in the bank. So many customers have decided not to take the risk and withdraw funds.
Unfortunately, that’s where the higher rates came in. Like most banks, Silicon Valley Bank had a bond portfolio to earn interest income, but a lot of its bonds were good. long-term Treasury securities classified as “held to maturity” on their balance. sheet, meaning they are recorded at their original purchase cost. But as interest rates rise, bond prices fall. Faced with selling off its bond portfolio to offset increased deposit withdrawals, the company actually had a bond portfolio worth far less than what was shown in its financial statements.
This is all quite unique to Silicon Valley Bank. First Republic, for example, has been hit by the contagion in part because it is another Silicon Valley-based bank. But it has more than 1/3 of its customers’ deposits with retail customers and less of a balance sheet gap than the SIVB. In the same way, Western Alliance Bank (WAL)which has a large portion of corporate clients, only has around 15% exposure to tech and life sciences filings and less than 2% to HTM stocks.
Rosenbluth: The good thing for investors is that the regional banks directly affected represented only a small part of the Selected Financial Sector SPDR Funds (XLF) or even the SPDR S&P Regional Banking ETF (KRE). Regional banks represent a slice of the broader financial sector, which itself only accounts for 10% of the S&P 500 index. One of the benefits of using ETFs is diversification!
But the bad news is that the fear of the next bank failure could lead to broader pressure on these ETFs. As Roxanna said, the sentiment is quite negative, and it may take more government involvement to change that.
Islam: Yes, good point. At the time of its collapse, Silicon Valley Bank was only 1.0% of KRE and 1.4% of iShares U.S. Regional Banks ETF (IAT). As of yesterday, FRC was just 0.8% KRE and 1.9% IAT. So for regional bank ETFs, there is certainly some diversification towards individual companies.
The question is whether the contagion is spreading to the entire subsector. Also, worth noting: If we look at some of these fintech ETFs, like the ARK Fintech Innovation ETF (ARKF)these are actually up nearly 7% since last Friday as many of these companies are more tech or crypto related and become more attractive given the recent drop in yields.
Rosenbluth: I love it when you get back to what’s inside an ETF. Not all “financial” ETFs are the same. I assume that Silicon Valley Bank will be removed from the indices behind these ETFs in the coming days.
Islam: Yes. Additionally, as both banks were shut down by regulators over the weekend, it meant trading was halted at both Silicon Valley Bank and Signature Bank. Silicon Valley Bank last traded on March 9, while Signature Bank last traded on March 10.
Stacey Morris, Head of Energy Research: Briefly, on the subject of contagion, investors may have been surprised by how much oil prices and energy stocks sold off on Wednesday. Concerns about the economy in general and risk aversion sentiment in the market weighed on energy commodities. Benchmark oil prices in the United States fell more than 5% to levels not seen since December 2021. Weakness in commodities has in turn put pressure on energy stocks.
Importantly, energy infrastructure has been more resilient than major energy benchmarks or other energy sub-sectors, given their defensive qualities and fee-based business model. In volatile markets, the income offered by the mid-space can be particularly attractive for enhancing total return.
Rosenbluth: That’s a good point, Stacey. Although it sounds like a broader banking or finance story, banks can touch every industry. Investors worried about a slowing US economy will turn away from cyclical sectors like energy. But not all energy stocks are affected by the price of oil in the same way.
Morris: That’s right, Todd. Oil is clearly sensitive to the outlook for the global economy. To be fair, oil also had a rough day on Tuesday (down 4.6%), but the decline clearly accelerated on Wednesday when Credit Suisse focused on the subject.
Rosenbluth: That said, we seem to be finding some stability. XLF and KRE fell only slightly on Thursday, while the broader US markets were up. So maybe it won’t have lasting effects for the patient advisor and end customers who use market dips as a chance to buy.
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