This article is an excerpt from the InvestorPlace Digest newsletter. To get news like this delivered straight to your inbox, click here.
On Tuesday, the New York Stock Exchange surprised markets by immediately suspending all trading in First Republic Bank shares. The stock had been hovering at $3.50 before the halt on the possibility of a white-knight takeover or a potential government bailout.
This NYSE suspension quashed any hope of redemption and sent shares of other regional banks tumbling.
At first glance, value investors might sense an opportunity. First Republic rivals are now trading at value levels never before seen. PacWest Bancorp (NASDAQ:PACW) was trading at roughly 0.3X tangible book value before Friday’s surge. And Western Alliance Bancorp (NYSE:WAL) announced on May 3 that deposits had risen $1.2 billion since March 31. From an accounting standpoint, First Republic’s key rivals seem like they should muddle through.
However, today’s banking crisis runs deeper than pure numbers suggest.
That’s because we’re seeing a crisis of confidence. Even if these regional banks are 100% solvent, their slumping share prices are causing nervous bank customers to withdraw cash anyways. That risks forcing banks to raise capital to meet these requests, which could spook depositors, and so on.
It’s a self-fulfilling prophecy that can sink even the strongest of lenders. When investors bank stakeholders start getting skittish, even firms like Goldman Sachs (NYSE:GS) can require bailouts from the likes of Warren Buffett (as it did in 2008). It takes far more than a single-day rally to calm nerves.
The writers at InvestorPlace.com – our free stock market news and analysis website – have been on the story all week long.
So, as the 2023 banking crisis continues to develop, here are five banks that look like they could fold next…
PacWest (PACW)
Shares of PacWest sank another 40% on Thursday after the regional bank announced it was considering “all strategic options” for its survival. According to a poll by Gallup, almost half of Americans now worry that their bank deposits aren’t safe anymore, and the Los Angeles-based bank’s situation personifies these fears. Friday’s rebound still leaves the stock down over three quarters for the year.
In ordinary times, PacWest shares would have already seemed unattractive. The firm uses excess leverage to pump its below-average return on assets (ROA) into an above-average return on equity (ROE). It’s a risky strategy that places the firm squarely in the bottom quintile of American banks based on my risk metrics. PacWest ranks 183 out of 222.
The recent events at First Republic means that PacWest could now fall further in the ranks. The firm’s top 10 depositors represent 9.1% of total deposits, meaning that the actions of a handful of large businesses could deplete PacWest’s capital cushions within hours, if not minutes. Heavy media attention also means virtually every PacWest customer is seeing commentators fret about their bank on live TV.
PacWest could, of course, reward speculators handsomely if its board can engineer a timely sale. But for investors who don’t want to roll the dice, it’s best to stay away from this stock until the dangers pass.
For more on PacWest, see this story from InvestorPlace.com writer Josh Enomoto.
Western Alliance Bancorporation (WAL)
On Wednesday, Western Alliance released an unscheduled press report detailing the bank’s financial stability. According to the firm, deposits rose $1.2 billion this quarter, bringing its total figure to $48.8 billion. The board would further attempt to calm markets by issuing a $0.36 dividend per share – unchanged from the prior quarter.
Markets were clearly unmoved. Shares of Western Alliance plummeted another 58% that day. The company has now lost roughly 60% of its value this year.
In a sense, it’s strange that Western Alliance should make this list.
From a fundamental standpoint, the Phonex-based firm is on far better footing than either First Republic or PacWest. Based on my metrics, it ranks 80 out of 222 for financial stability. Western Alliance has also managed to keep returns high through careful cost control. Its efficiency ratio is a quarter better (i.e., lower) than the average bank.
Nevertheless, the firm has added leverage in recent years to turn its elevated ROAs into astoundingly high ROEs. The bank has an effective ratio of 12.6%, significantly higher than the average 10.2% carried by American banks. And because of its geographic proximity with First Republic, Western Alliance has been naturally compared by financial commentators to its failed counterpart.
Though Western Alliance is now my top banking stock to buy the dip on a risk-adjusted basis, not much has to go wrong for the firm to turn into the next First Republic. Be sure to know the risks.
InvestorPlace.com Financial News Writer Samuel O’Brient has more on Western Alliance’s potential fate.
Zions Bancorporation (ZION)
Zions Bancorporation (NASDAQ:ZION) is a 175-year-old financial institution based in Salt Lake City. In 2022, the company shed $3 billion from bad bets on fixed-rate securities, causing its equity value to fall to $4.9 billion.
These losses couldn’t come at a worse time for Zions. With the collapse of First Republic, Zions Bank has now received the dubious crown of being the most leveraged major bank on the U.S. stock market. Investors have sent shares down 57% this year.
Zions Bank now finds itself in an awkward position. The firm cannot tap public markets for additional equity, since doing so could spark a bank run. But Zion’s wafer-thin capital cushion prevents it from taking the riskier, higher-earning business required to “earn” its way out of its $3 billion loss from last year.
Zions managed to survive the 2008 financial crisis by raising $1.4 billion in TARP funds (read: bailout) from the U.S. government. This time around, the Federal Reserve has indicated that no such help is on the way. Investors buying today have no safety net that existed in 2008.
Two More Banks on the Edge
The picture for regional banks becomes even grimmer as we consider smaller institutions.
Republic First Bancorp (NASDAQ:FRBK). The Philadelphia-based bank has lost 67% of its stock market value this year as investors begin to question its financial strategy. Republic First generates relatively low profits from its abnormally conservative 48% loan-to-deposit ratio and makes up the difference with a high effective leverage ratio. In ordinary times, investors don’t particularly mind trading out operational leverage for the financial type. But as the 2023 banking crisis plays out, Republic First’s management are quickly realizing why few other banks follow that risky model.
HomeStreet (NASDAQ:HMST). Formerly known as Continental Savings Bank, this Seattle-based regional lender has seen its shares plummet 80% already this year. In 2022, HomeStreet lost 14% of its equity value from unrealized losses in its security portfolio, sending its Tier 1 capital ratio to 9.5%. As a reminder, any figure less than 10% is a red flag. That, paired with an unusually high cost structure, puts the firm at an elevated risk of a bank run.
To read more about my thoughts on the health of American banks at InvestorPlace.com, click here.
Where Will Bank Stocks Go From Here?
In March, Eric Fry called the 2023 regional banking crisis “fatal, but not serious”…
It may be fatal to Silicon Valley Bank (OTCMKTS:SIVBQ), but it does not pose a serious threat to the stock market or to the broader U.S. financial system…. The assets supporting bank balance sheets bear no resemblance to the mortgage-backed refuse that littered balance sheets in 2007-2008.
Eric has been correct so far on all counts. Weaker players like First Republic have collapsed without taking the broader financial system along with it. And no 2008-type asset has since been unearthed.
Today, a new truth is also emerging: The U.S. Federal Reserve has no interest in saving smaller banks as it did in 2008. That same TARP money that rescued Zions Bank and others from bankruptcy 15 years ago is nowhere to be seen. And unlike the Wachovia-Wells Fargo merger of 2008 or the Credit Suisse-UBS one earlier this year, shareholders of failing regional banks are walking away with nothing.
That presents a contagious problem. Foreign exchange and commodity traders have long known that markets can become a self-fulfilling prophecy. If enough traders believe, say, cotton will run a shortage, they may begin stockpiling the crop as they did in 2011 and 2022. That reduces spot availability and creates a real-world shortage caused by nothing more than a belief.
The same is now proving true for regional banks. Investors are beginning to believe that failing regional banks will leave shareholders with nothing. That’s causing markets to price shares lower, causing a self-fulfilling prophecy.
Though the 2023 banking crisis is likely not a concern to the U.S. financial system, the investors of these firms are only beginning to realize that balance-sheet strength has little to do with stock market returns when banks are involved.
As of this writing, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.