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The 2023 local bank crisis hit capital markets almost exactly one year ago, with Silicon Valley Bank (SVB) failing and local bank ETFs falling 30% in the first two weeks of March.
Long Island-based New York Community Bank’s (NYCB) intraday price crash of more than 40% on Wednesday was a stark reminder that weakness in the local banking sector remains.
Investors should look at the causes of the 2023 crisis, market reaction, to better understand what risks remain and whether such a crisis could occur again in 2024. , it would be wise to reconsider the impact on regional bank ETFs.
What happened in the local bank crisis in 2023?
The 2023 local bank crisis is a series of bank failures and bankruptcies that occurred during the first few months of 2023, with the largest impact on the local bank ETF occurring in March. A summary of the main events and factors follows:
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March 2023: Silicon Valley Bank (SVB), a California bank with deep ties to high-tech startups, was the first major victim. Facing $1.8 billion in losses and a credit rating downgrade, the company went bankrupt as wealthy customers withdrew billions of dollars, leading to its bankruptcy.
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After SVB failure: Other local banks, including Signature Bank and First Republic Bank, also faced difficulties. Stock prices fell sharply, raising concerns about the health of the local banking sector.
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Federal intervention: The Federal Deposit Insurance Corporation (FDIC) intervened in failing banks, protecting insured deposits and facilitating their sale or merger with other institutions.
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Impact of local bank ETFs: Exchange-traded funds (ETFs) that invest in local banks fell nearly 30% in the first two weeks of March 2023. SPDR S&P Regional Bank ETF (KRE).
Impact of rising interest rates on commercial real estate
The fundamental weaknesses that caused the regional banking crisis in 2023 will remain in 2024. Today’s high interest rate environment and low occupancy rates are putting pressure on commercial real estate companies and the local banks that finance them. Below is a summary of the main factors that still exist in 2024 that could negatively impact local banks.
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Rising interest rates and borrowing costs: The Federal Reserve began raising interest rates at the end of 2022 to combat inflation. This increase in borrowing costs squeezed profit margins, as banks earn interest on loans but pay interest on deposits.
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Vulnerabilities of local banks: Compared to large national banks, many regional banks rely more on short-term funding and have greater exposure to certain sectors, such as commercial real estate. This makes them more vulnerable to sudden changes in economic conditions.
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Commercial real estate weaknesses: The commercial real estate market was facing headwinds due to factors such as remote work trends and oversupply in certain regions. This led to loan defaults and increased risk for banks with significant investments in the sector. Commercial real estate occupancy rates are currently at record lows.
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Mismatch in terms of assets and liabilities: At some local banks, the life of assets and liabilities did not match. They held long-term assets (loans) funded by short-term liabilities (deposits). As interest rates rose, funding costs (deposit interest payments) increased faster than income from existing loans (fixed rate), resulting in losses.
What caused the NYCB stock crash?
On March 6th, the stock price of New York Community Bancorp (NYCB) fell sharply. Here’s a breakdown of the event and what happened next.
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Early trading slump: The trading day of March 6th started with a sharp decline in NYCB stock, which fell as much as 42% to its intraday low. The plunge came amid financial media reports that struggling regional banks are seeking capital injections from outside investors to shore up their balance sheets.
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Cause for concern: The news raised concerns about NYCB’s financial health. The bank has already made several changes in early 2024, including exposing “material weaknesses” in its internal loan review management, reporting significant losses in the fourth quarter of 2023, and appointing a new CEO after the previous CEO’s resignation. It was revealing worrying signs.
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Market reaction: These factors, combined with news calling for a cash injection, led to investor selling and a significant drop in stock prices.
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Unexpected reversal: But later that day, the story took a surprising turn. NYCB announced an agreement for a capital injection with a group of investors led by investment banker and former Treasury Secretary Steven Mnuchin’s firm. This news seemed to restore some confidence in the market, and NYCB’s stock price rebounded significantly. By the close of trading, the stock had closed more than 7% higher than its opening price.
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Impact of local bank ETFs: The KRE ETF only fell about 3% on March 6, as most of the decline was confined to NYCB stock, which is only 1.3% of the fund’s portfolio.
Regional Bank ETF Returns in 2024
The March 6 collapse and recovery in NYCB stock reminded investors that the weaknesses in the local banking sector that were exposed in 2023 still linger. Commercial real estate faces significant economic headwinds, including high interest rates and low occupancy rates, increasing the risk of default on loans from local banks.
The 2023 regional banking crisis and the 2024 NYCB stock price collapse highlighted the interconnectedness of the financial system and the potential vulnerability of regional institutions during periods of rising interest rates and slowing economic activity. He also emphasized the importance of risk management and diversification for banks of all sizes and the ETFs that own them.
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