The Regional Banking Crisis, One Year Later

A little over a year ago, the failure of Silicon Valley Bank and Signature Bank New York sent shockwaves through markets, with many concerned about the health of the U.S. and global financial system. Fears of a second Global Financial Crisis permeated the news, and expectations for recession rose to over 75%.¹

None of these worst-case scenarios came to fruition.

In fact, the U.S. economy and stocks moved in the opposite direction. The S&P 500 experienced a sharp but relatively small pullback of -8% in light of the bank stress, but ultimately finished 2023 up +26%. Regional bank stocks felt the pain throughout the year, but larger banks fared much better, and the banking system as a whole remained well-capitalized. The U.S. economy continued to grow even as loan growth slowed, and U.S. consumers seemed unfazed – bolstered by a historically strong labor market.

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In Quarters Following Regional Bank Stress, the U.S. Economy Continued to Grow

As seen in the chart below, U.S. consumers continued to spend firmly since the beginning of 2023, even when adjusted for inflation.

Consumer Spending Was Not Deterred by Regional Bank Stress

For investors with diversified portfolios providing exposure to different sectors, industries, and sizes/styles, the regional bank stress of early 2023 likely did not prove much of a factor in returns at all. But that doesn’t necessarily mean there was no pain experienced anywhere in the market.

For regional banks in particular but also banks in general, higher interest rates have resulted in some competition for deposits – which puts pressure on banks’ net interest margins. This has created acute risks for regional banks in particular, which fear deposit flight, especially from wealthier clients. Banks also needed to take a hard look at their balance sheets, to identify unrealized losses from Treasury bonds purchased at ultra-low rates.

Then there’s the matter of regional bank exposure to commercial real estate (CRE). CRE loans make up a much larger percentage of small bank balance sheets than large banks. In some cases, CRE loans can be up to 30% of a small bank’s assets on a balance sheet, compared to about 5% to 6% average for large banks. We have not seen a wave of delinquencies in these loans so far, but the state of office real estate in the U.S. suggests that at least some levels of defaults are in the offing. Taken together, many regional banks look under-capitalized when taking all of these factors into account.

Zooming out again to look at the banking sector in the U.S. as a whole, we continue to see an environment where loan growth has slowed but looks stable, and larger banks remain very well-capitalized and liquid. Overall, we don’t see any major risk of financial instability as a result.

Loan Growth Declined Substantially Starting Last March, but Has Stabilized

Bottom Line for Investors

Another key takeaway from last year’s regional bank stress was how swift and decisive the response was from the U.S. Treasury, the Federal Reserve, and the FDIC. Markets were very receptive to the backstops to deposits put into place, and assurances that liquidity would be made available for banks to access if need be – the so-called Bank Term Funding Program. That program was unwound earlier in April, as the sector appeared fully stable, and the funds were arguably not needed any longer.

Looking ahead, the experience has the Fed and other governing bodies rethinking bank regulations, to ensure adequate capitalization, liquidity, and risk management processes that could help banks avoid serious problems in the future.

Most investors can get where they need to go over the long term by owning a diversified portfolio of stocks and/or ETFs. In fact, “diversify your portfolio” is one the most basic pieces of investing advice. Sadly, in our experience many investors still put all (or most) of their eggs in one basket.

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¹ J.P. Morgan. March 15, 2024.

² Zacks Investment Management may amend or rescind the Is Your Investment Portfolio Actually Well-Diversified? guide offer for any reason and at Zacks Investment Management’s discretion.

³ BEA. April 25, 2024.

⁴ Fred Economic Data. April 26, 2024.

⁵ Fred Economic Data. April 26, 2024.

⁶ Zacks Investment Management may amend or rescind the Is Your Investment Portfolio Actually Well-Diversified? guide offer for any reason and at Zacks Investment Management’s discretion.

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