22 May 2023
Curt Organt, Portfolio Manager
The banking sector is an integral part of the U.S. small-cap investment universe
Key Insights
March 2023 marked a period of extreme duress in the U.S. banking industry, with ripple effects around the globe. Two U.S. banks, Silicon Valley Bank (SVB) and Signature Bank (SBNY), collapsed after both suffered runs on their deposit base. At the time of writing, a handful of other banks have faced liquidity pressures. On May 1, 2023, First Republic Bank (FRC)1 was seized by U.S. regulators and substantially all assets have been purchased by JP Morgan Bank. The impacts of these failures, and the rapid withdrawal of deposits across some regional U.S. banks, has been profound. For U.S. smaller company investors, recent developments are acutely relevant given that regional banks—there are 216 of them listed on the Russell 2500 Index2—represent a key component of the small‑ and mid‑cap (SMID) company investment universe. With this in mind, we consider the outlook for U.S. regional banks and their potential impact within smaller company portfolios.
The Issue Today Is Liquidity, Not Credit
An important distinction between the crisis SVB and SBNY faced in 2023, and what occurred during the global financial crisis (GFC) of 2008 and 2009, is that today’s crisis is driven by liquidity issues, not credit issues in banks’ loan portfolios. The GFC was chronic stress in the loan portfolio that took years to build up. Once the issue was uncovered, banks could identify how much capital was required and raise the capital, and then the crisis was relatively controlled.
No bank can control the outflow of deposits it may face—either the magnitude or the timing.
No bank can control the outflow of deposits it may face—either the magnitude or the timing. The amount of capital needed to fund the sheer volume of withdrawals that SVB, SBNY and FRC faced was more than could be raised in the time they had available.
Not All Banks Face the Same Fate
The media is focused on a handful of banks under extreme pressure, and the coverage of the issues these banks are experiencing is warranted given the potential for broader impacts on the financial system. That said, the reality is that a large portion of the regional bank universe has not faced material outflows of deposits. In the week following the collapse of SVB and SBNY, the large majority of regional banks had either seen no material change in deposits or had seen positive deposit flows. Larger money center banks, perceived as “too big to fail,” are to some extent gaining deposits at the expense of the regional banks, but the shift has been muted, to date.
Wide Distribution of Bank Performance, Post Collapse
There are 216 regional banks in the Russell 2500 Index and relatively few of them are currently facing the same financial or stock performance issues as SVB and SBNY. From SVB’s failed capital raising on March 8, 2023, through to the time of writing on March 173:
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1First Republic Bank (FRC) is not included in the Russell 2500 Index, and we had no exposure in this strategy’s representative portfolio as of March 31, 2023. The representative portfolio is an account we believe most closely reflects current portfolio management style for the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from those of other accounts in the strategy. Information regarding the representative portfolio and the other accounts in the strategy is available upon request.
2As of March 17, 2023. Source: Frank Russell Company “LSE.”
3As of March 17, 2023. Sources: FactSet, Frank Russell Company “LSE.” Analysis by T. Rowe Price.
The specific securities identified and described are for informational purposes only and do not represent recommendations.
Risks—The following risks are materially relevant to the portfolio:
Small and mid‑cap—Small and mid‑size company stock prices can be more volatile than stock prices of larger companies.
General Portfolio Risks:
Equity—Equities can lose value rapidly for a variety of reasons and can remain at low prices indefinitely. ESG and sustainability—ESG and Sustainability risk may result in a material negative impact on the value of an investment and performance of the portfolio. Geographic concentration—Geographic concentration risk may result in performance being more strongly affected by any social, political, economic, environmental or market conditions affecting those countries or regions in which the portfolio’s assets are concentrated. Investment portfolio—Investing in portfolios involves certain risks an investor would not face if investing in markets directly. Management—Management risk may result in potential conflicts of interest relating to the obligations of the investment manager. Market—Market risk may subject the portfolio to experience losses caused by unexpected changes in a wide variety of factors. Operational—Operational risk may cause losses as a result of incidents caused by people, systems, and/or processes.
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