Background

In recent months, 3 regional banks failed creating the most stress in the banking system since the dark days of the 2008 financial crisis. The speed at which Silicon Valley Bank (SVB) and Signature Bank failed in March, and First Republic Bank failed in May, surprised the market.  While asset quality was never the primary issue, other factors were at play that ultimately sunk these banks, including concentrated deposits that exited the banks quickly and losses in their large security portfolio resulting from the Federal Reserve’s aggressive rate hikes.

Market conditions

The bonds of other banks, both regional and money center, came under pressure since most institutions had some of the same challenges of those that failed.  Savers were emboldened to move money from traditional banks, seeking higher yields in U.S. Treasury securities, CD’s, and other types of bonds, where yields had risen sharply. While government and Federal Reserve emergency programs largely mitigated the negative effects of the current environment for most banks, there are still profitability challenges ahead, as well as the prospect of higher capital mandates, especially for large regional banks.

Option-adjusted spreads

Source: Bloomberg, 5/31/2023; FITB: Fifth Third Bancorp, USB: U.S. Bancorp, KEY: KeyCorp, PNC: The PNC Financial Services Group, Inc., TFC: Truist Financial Corporation.

Our viewpoint

While these challenges have put pressure on the stock and bonds of individual institutions, opportunities have emerged. Even as the outlook for regional bank equities remains uncertain due to the likelihood of reduced profitability, our team believes that the increased capital requirements and other factors are likely to be positive for bondholders over time.  While we are off the widest spreads, valuations remain attractive, and opportunities still exist especially in shorter maturity bonds. We have added several large regional names such as PNC, USB and TFC to many Wasmer Schroeder separately managed accounts and expect to be opportunistic in this sector for the remainder of 2023.