Following an aggressive interest rate hiking cycle throughout 2022 and 2023, cracks began appearing in the U.S. banking sector by March, disproportionately affecting smaller regional banks.
After numerous bank runs, high-profile failures, liquidations, and acquisitions, the U.S. government stepped in, intervening to ensure liquidity and the integrity of deposits. Still, worries linger in the sector especially as the Fed remains committed to further rate hikes.
With exposure to U.S. regional bank stocks, certain ETFs have also been hit hard due to concentration risk in the regional banking industry and broader financial sector. Here's all you need to know about the ongoing regional banking crisis as an ETF investor.
U.S. Regional Bank Failure: Background and timeline
The first institution to fall was Silvergate Bank, a California-based bank known for its heavy involvement in the cryptocurrency market. Following the collapse of crypto exchange FTX, Silvergate experienced a bank run as clients panicked about its high percentage of crypto-related deposits.
Unable to meet the increasing withdrawal requests from clients, Silvergate began selling assets at a loss, leading to a voluntary liquidation in March 2023. Exacerbating this was high mark-to-market losses on their fixed-income portfolio caused by the ongoing interest rate hikes.
The next to go was Silicon Valley Bank (SVB), a commercial bank focused on serving the technology industry. SVB faced many of the same issues as Silvergate, with mark-to-market losses on their fixed-income portfolio and a panicked clientele base seeking withdrawals for cash it did not have on hand.
Again, this cumulated in a bank run, which ultimately led to the seizure of SVB by the California Department of Financial Protection and Innovation (DFPI) and its placement under the receivership of the Federal Deposit Insurance Corporation (FDIC) to guarantee deposits, even those uninsured.
Finally, the contagion spread to First Republic Bank (OTC:FRCB) (FRB). After shares fell by over 60% on March 13th, the bank sought emergency financing to shore up its liquidity from large U.S. banks, the most notable of which was JPMorgan Chase (NYSE:JPM). However, these efforts ultimately proved insufficient.
By April, the bank reported an outflow of over $100 billion in deposits, causing its share price to plunge again. In response, FRB announced plans to sell bonds and securities at a loss and lay off employees, but its stock price continued to plummet, which spooked depositors even more.
Eventually, the FDIC confirmed plans to seize the bank, and on May 1st, FRB was shuttered, with its assets being sold to JPM for around $10 billion U.S. dollars. This was an eerie throwback to 2008 when the latter acquired both subprime mortgage lender Washington Mutual and competitor Bear Stearns.
Today, all eyes are on PacWest (NASDAQ:PACW) and Western Alliance (NYSE:WAL), with shares of each falling around -30% and -21% the week of May 1st to May 5th. Despite declarations from both banks that their liquidity is strong, spooked investors continue to sell both stocks short, leading to calls for greater regulations on short selling during a banking crisis.
Bank ETFs to watch
ETFs like the SPDR® S&P Regional Banking ETF (NYSE:KRE), the iShares U.S. Regional Banks ETF (NYSE:IAT), and the Invesco KBW Regional Banking ETF (NASDAQ:KBWR) were down around -35%, -34%, and -28% respectively as of May 8th, 2023. This is unsurprising given the pure-play exposure all three ETFs possessed.
Dividend ETFs with a higher allocation to financial sector stocks and especially higher-yielding regional bank stocks suffered losses too. For example, the popular Schwab U.S. Dividend Equity ETF™ (NYSE:SCHD) is down over -6% year-to-date while the S&P 500 is up just over 8% on the back of positive tech sector earnings.
Overall, broad financial sector ETFs are still holding up better thanks to their market cap-weighted nature. For example, the popular Financial Select Sector SPDR® Fund (NYSE:XLF) is only down around -6% thanks to its focus on S&P 500 financial sector equities.
Hardest hit was the Direxion Daily S&P500® Bull 3X Shares (NYSE:SPXL) (DPST), which offers three times daily leveraged exposure to the return of the S&P Regional Banks Select Industry Index. The ETF fell from a 52-week high of 39.18 to trade as low as $3.46 at one point. Year-to-date, DPST is still down around 78%. Further losses could prompt Direxion to implement a reverse split for this ETF.
This content was originally published by our partners at ETF Central.