US Bank Collapse: What happened?

The U.S. regional banking crisis commenced in March, primarily as an effect of the multiple interest rate hikes made over the past year and recession worries which dried up demand for loans by small firms and startups - the focus group for regional banks. 

Silicon Valley Bank was the first casualty of high interest rates which further spread to cause a widespread pandemonium with investors pulling out all their money from small regional lenders to flee to the safety of larger, well established banks like JP Morgan and Bank of America.

A total of three regional US banks have faced closure - Silicon Valley Bank, Signature Bank and First Republic Bank all shut shop between March and April this year.

The turmoil surrounding these three regional bank failures have also had an adverse impact on stock prices for the entire sector. For instance the SPDR S&P Regional Banking ETF has dropped 31% since the beginning of March this year, depicted through the below graph:

US Bank Collapse: Why did Silicon Valley Bank, First Republic Bank and Signature Bank fail?

The core issue for regional banks was the relentless interest rate hikes made by the US central bank and its direct impact on bond prices. A bond is considered to be the safest investment avenue and bond issued by the US Government is the safest financial instrument in the world. 

As interest rates rise, so do bond yields. Bond yields and bond prices have an inverse relationship. Now majority of these banks buy government issued bonds and as the value of these bonds drop, it affects the bank’s liquidity situation. 

After the negative effects of interest rates, all these banks had a asset-liability mismatch in their portfolio:

Silicon Valley Bank

• The bank was a key lender to budding startups and had major venture capitalists (VCs) as its clients who had large amounts of deposits with the bank which it used to lend to early stage startups.  
• SVB's deposits jumped 3x to $189.20 billion in 2021 amid the boom in VC business. However, the withdrawals didn't happen much because the IPO Boom was over in 2022 (2021 had 1035 IPOs, 2022 had only 151).  
• Furthermore, the bank had very few retail depositors who generally tend to keep money in the bank for longer durations. Instead the bank’s deposit mix was highly skewed towards institutional clients who have a more erratic deposit-withdrawal ratio. 
• SVB also made the error of investing its surplus funds into mortgage backed securities. These instruments also suffered due to rising interest rates. 

First Republic Bank

• The bank primarily catered to high net worth individuals and after SVB bank collapsed, all of them withdrew their deposits leaving the bank with little to no deposits left in its coffers. 
• Why did high net worth individuals pull out? Its because the US government insures deposits only upto $250,000 in case a bank shuts, which led to high net worth individuals pull out their deposits.
• First Republic Bank lost 100% of its value since March this year. 

US Regional Banks: Share price performance

US Regional Banking Failure: PacWest Bancorp to fail next?

It appears that PacWest Bancorp is facing difficulties as its stock price plummeted by approximately 52% during after-hours trading as on May 3 2023. This drop came after news surfaced that the bank was considering various strategic alternatives, such as a possible sale or raising capital.

PacWest said in a statement that it had not experienced any unusual deposit outflows since JP Morgan bought First Republic Bank on Monday. It added that the planned sale of its $2.7 billion lender finance loan portfolio

In all, the regional banking space in the US has received a severe jolt due to interest rate pressure. However, the US central bank in its latest monetary policy meeting furnished plans to refrain from further rate hikes for the rest of 2023.

PacWest Bancorp share price performance

This is not investment advice. Investments in the securities market are subject to market risk, read all the related documents carefully before investing. Past performance is not indicative of future returns.