What happened
Shares of many regional banks sold off heavily in March after the collapse of three U.S. banks in less than a week's time sent a jolt through the industry and left investors quite uncertain about the future.
Between Feb. 28 and March 31, shares of First Republic (FRCB) fell an astounding more than 88%, according to data from S&P Global Market Intelligence.
Meanwhile, shares of the fifth-largest bank in the country by assets, US Bancorp (USB 1.56%), fell close to 25%, while shares of the seventh-largest bank in the U.S., Truist Financial (TFC -0.13%), fell by more than 27%.
Image source: Getty Images.
So what
In the first half of March, there was a string of U.S. bank collapses. First, Silvergate Capital, after experiencing a significant run of deposits among its crypto clients at the end of 2022 and the beginning of this year, announced it would wind down its operations and liquidate its assets.
Then Silicon Valley Bank, part of SVB Financial, was taken into receivership by the Federal Deposit Insurance Corp. (FDIC) after it saw $42 billion in deposit outflows in a single day, with more being requested the next day. A few days later, regulators announced that Signature Bank had also been closed, and it was eventually put into FDIC receivership. Shortly after these events, Credit Suisse was forced into an acquisition by regulators after it looked like the bank might collapse itself.
These events have undoubtedly rocked the entire sector and had bank investors looking hard at the amount of uninsured deposits a bank has and unrealized losses in their bond portfolios, which are two of the big issues that led to the demise of the three U.S. banks.
First Republic has likely experienced the most trouble of any bank that hasn't yet failed. The bank had a lot of uninsured deposits and billions of unrealized bond losses. It also operates in a similar location and had some client overlap with SVB Financial.
Media outlets reported that First Republic experienced an incredible $70 billion in deposit outflows. Borrowings at the bank surged in mid-March, and 11 of the largest U.S. banks injected $30 billion of deposits into First Republic.
Most regional banks have been sold off since all the chaos started, but there have been concerns about US Bancorp and Truist because of the amount of unrealized bond losses these banks have in their held-to-maturity (HTM) bond portfolio.
As the name suggests, HTM bonds are those a bank intends to hold to maturity, so their gains and losses are not incorporated into a bank's equity calculation each quarter. These bond portfolios are currently underwater right now because bond values have been crushed by rising interest rates. As long as the bonds don't have to be sold, banks are able to recoup the losses once the bonds mature or as bond yields come down. But if deposit outflows accelerate and these banks have to sell the bonds at a loss, they could wipe out a significant amount of shareholder equity.
At the end of 2022, US Bancorp was sitting on $10.9 billion in unrealized HTM losses relative to its $29.7 billion of tangible common equity. Meanwhile, Truist was sitting on $9.9 billion of unrealized losses relative to its $23.9 billion of tangible common equity. Both banks have a higher amount of unrealized losses relative to their peer group.
Now what
Although First Republic is still hanging in there and may survive, I am still worried about the bank because I think its earnings could be in real trouble. First Republic has likely had to replace the deposits that left the bank with higher-cost funding, and the bank does not have a high-yielding loan portfolio or a very asset-sensitive balance sheet. As such, I would avoid the stock.
While the environment is still somewhat uncertain, I feel much better about US Bancorp and Truist because both have huge, well-diversified deposit bases that I do not believe will experience a material run. As such, I view these two names as buying opportunities, although as I've said in the past, it likely makes sense to start with a smaller position and build from there as things become more clear.
