Bank stocks have come under some pressure this month after the second- and third-largest bank failures in history came out of seemingly nowhere and spooked investors. In particular, bank stocks First Republic (FRCB), PacWest Bancorp (PACW), and Western Alliance (WAL -0.75%) went on quite a bumpy ride as investors spotted similarities between their balance sheets and those of failed bank SVB Financial. As a result, all three stocks have been sold off intensely.
To paraphrase legendary investor Warren Buffett, with so many investors so scared right now, is it time to "be greedy when others are fearful?" Given the sell-off, are any of these stocks worth buying right now? Let's take a look.
Uninsured deposits and bond losses
The big thing that brought SVB Financial's Silicon Valley Bank and Silvergate Capital's Silvergate Bank down is deposits fleeing the bank extremely quickly over concerns about bond losses. Many banks invested excess deposits into lower-yielding, longer-duration bonds too early in the interest rate cycle. When rates rose, these bonds fell out of favor and their value fell deeply underwater because bond yields and bond values have an inverse relationship. Given enough time, these "paper losses" on the bonds would have turned back into gains if the bonds were held to maturity. SVB didn't get that needed time.
What exacerbated SVB's and Silvergate's problems is that both banks had too much deposit concentration among a smaller number of big customers, all carrying deposit balances well in excess of what the Federal Deposit Insurance Corp. (FDIC) insures. In SVB's case, once the liquidity issues it faced became known, these select large customers got spooked, pulled their deposits quickly, and then told their friends to do the same. Word got around so quickly that SVB saw an astounding $42 billion of deposits pulled in a single day.
Making comparisons to SVB Financial
In order to see how First Republic, PacWest, and Western Alliance stack up to SVB, let's first examine how many of their deposits were uninsured and what kinds of bond losses they were facing relative to their tangible common equity (TCE) at the end of 2022. I'm only going to look at unrealized bond losses in these banks' held-to-maturity (HTM) portfolios because these are not marked-to-market and therefore not subtracted from equity each quarter.
| Bank | TCE | HTM Unrealized Losses on Dec. 31, 2022 | Percent of Deposits Uninsured on Dec. 31, 2022 |
|---|---|---|---|
| SVB Financial | $11.8 billion | $15.1 billion | 89% |
| First Republic | $12.8 billion | $4.8 billion | 79% |
| Western Alliance | $4.4 billion | $177 million | 76% |
| PacWest Bancorp | $2.12 billion | NM | 57% |
Data sources: Bank call reports and regulatory filings. TCE = Tangible common equity. HTM = Held to maturity. NM = Not material.
As you can see, SVB would have wiped out all of its equity if it had sold its HTM bond portfolio. First Republic would wipe out 37.5% of its equity, while Western Alliance and PacWest aren't really sitting on any meaningful HTM bond losses. However, all of these banks had a significant amount of uninsured deposits.
Homing in on deposits
First Republic is a niche bank catering to high-net-worth households in the coastal parts of the U.S. like California, New York, Boston, and Florida. Like SVB, it also does a good amount of lending to businesses like venture capital and private equity firms, as well as nonprofits such as higher education.
Interestingly, First Republic notes that it only has one-fifth of business deposit accounts compared to the average U.S. bank with between $100 billion and $250 billion in deposits. The bank also noted in a recent investor presentation that its average business account has $490,000 in deposits in it, so you can see how a deposit base like this could potentially flee quicker than somewhere like Bank of America, which has millions of consumer accounts with much smaller balances.
Despite tapping the Federal Reserve and JPMorgan Chase and building unused liquidity of $70 billion, First Republic was apparently still seeing deposit outflows and had to get an additional $30 billion deposit injection from 11 different banks.
Western Alliance mainly gathers deposits from companies as well but seems to have a somewhat more diverse set of customers, serving a wider range of businesses, mortgage companies, homeowner's associations, and business escrow services. Roughly 14% of the bank's deposits came from the tech and innovation sector.
PacWest also heavily caters to the venture capital community. At the end of 2022, about $12 billion of its nearly $34 billion in deposits came from venture banking activity, and the bank is reportedly seeking additional liquidity similar to First Republic.
Margin and insider buys
A good indicator of a bank's profitability is its net interest margin (NIM), which essentially looks at the interest a bank makes on interest-earning assets such as loans and securities and what it pays out on interest-bearing liabilities like deposits.
First Republic is definitely going to be challenged, as it had already been facing NIM pressure even before all of the chaos started because it holds a large mortgage portfolio, which tends to yield less than a lot of business and commercial loans. Considering the bank recently said it has taken on a lot of higher-cost borrowings to fill the hole from outflows, expect earnings to struggle, especially over the next few quarters.
On its first-quarter earnings call back in January, PacWest's management team expected NIM to be flat in 2023, but this has likely changed given everything going on.
On Western Alliance's Q1 earnings call, management actually guided for very strong deposit growth in 2023 of between 13% and 17% and NIM expansion this year. Last Friday, as SVB Financial was being put into FDIC receivership, Western Alliance reaffirmed its deposit growth projections for the year, although it will be interesting to see how those hold up. On March 13, the bank said it had increased cash balances to $25 billion and that insured deposits now exceeded 50%, which are all positive developments.
In terms of recent stock purchases by management and directors, PacWest takes the cake, with many members of its senior management team and directors purchasing shares since SVB failed. As of March 16, only one director at Western Alliance had purchased shares, and at First Republic, one member of senior management sold shares in recent days and one director acquired shares on March 9.
Are any of these stocks worth buying?
The big thing to understand here is that this is a rapidly evolving situation, so expect a lot of volatility over the next few weeks and there's no guarantee that more regional banks won't face deposit runs. These three banks may also see credit downgrades from the rating agencies (First Republic already has). I also think First Republic is a likely seller if it can find a buyer because it could really be an uphill battle for the bank from an earnings perspective.
Additionally, regional banks definitely face challenges moving forward, whether it's on earnings or on the regulatory front. So while I expect them to rebound, it may not be an easy road and they may not gain their former valuations, at least for a while.
All that said, Western Alliance looks the best positioned of these three right now given their cash position and the fact that more than half of the bank's deposits are now FDIC-insured. The company also has better NIM expectations and looks to have a more stable, diverse deposit base. I do wish insiders were buying more shares, however, because it would be a good signal to the market.
If you're interested in investing, the best thing to do right now is to take a small position and build it gradually as conditions stabilize. Another way to play this might be to purchase an exchange-traded fund with exposure to regional banks like the SPDR S&P Regional Banking ETF, so you get exposure to a basket of regional bank stocks.
