Regional bank stocks look set to rebound Friday but are still down sharply this week, accentuating fears that federal regulators have not yet contained a crisis in the sector that could shake the financial system.
What's happening: PacWest shares lost half their value on Thursday after the California-based lender said it was exploring all strategic options. Shares of Arizona's Western Alliance finished down 39% despite the company's denouncement of a Financial Times report it was considering a sale. Utah's Zions and Texas' Comerica both suffered stock declines topping 12%.
What's particularly alarming, according to industry insiders? These banks weren't seeing depositors rush for the exits when investors panicked.
"The bank has not experienced out-of-the-ordinary deposit flows following the sale of First Republic Bank and other news," PacWest said in a statement, noting that 75% of its deposits were insured as of May 2.
Breaking it down: Wall Street is on the hunt for any signs of vulnerability in the banking system after the high-profile demise of Silicon Valley Bank, Signature Bank and First Republic Bank in a matter of weeks. While authorities stepped in to protect depositors at those banks, investors were left with stocks that were suddenly worthless. Now, they're anxious to get ahead of the next shoe to drop.
But skittishness can become a self-fulfilling prophecy. Customers may see a drop in their bank's share price, assume it's in trouble, and yank their funds. Banks fail when too many people try to withdraw their deposits at once.
"Unfortunately, there's a feedback loop here," said Tom Michaud, the CEO of Keefe, Bruyette & Woods, an investment bank that specializes in financial services.
That means this bout of instability may require a circuit breaker.
"I believe it really only ends after we get some type of government intervention," Michaud told me. Without one, he continued, "the market will keep testing weak links — or perceived weak links."
Michaud is advocating for the US Federal Deposit Insurance Corporation — which guarantees deposits up to $250,000 per person, per bank — to protect all deposits in the United States for one year.
That time-limited measure would help financial markets calm down and provide space for Congress to modernize the deposit insurance framework, ensuring it's set up for the age of social media, rapid bank transfers and a growing pile of uninsured deposits, all of which can fuel or exacerbate bank runs, he said.
"The simplest way to do it is [to] insure everybody for a year until we can figure it out," he said. "We need a time-out."
Meanwhile, Stephen Biggar, director of financial institutions at Argus Research, is concerned that swings in regional bank stocks may be intensified by short-selling, a practice in which an investor bets against a stock and benefits when its price falls.
The value of short positions in regional bank stocks reached $15.1 billion in mid-April, up from about $13.7 billion one year ago, according to data from S3 Partners. Its analysts have tracked $569 million in new short-selling over the past 30 days.
"If there's a discovery there's an enormous amount of short-selling going on, I think — for the fabric of the banking system itself — that should not be allowed to stand," Biggar said, noting short-selling restrictions were imposed in March 2020 during the thick of the panic surrounding the Covid-19 pandemic.
He also said the Biden administration — which has ramped up antitrust enforcement generally, raising questions about whether mergers will be approved — should signal that it supports more consolidation among small and medium-sized players in the sector. That would ensure depositors don't see the handful of big US banks, such as JPMorgan Chase and Citigroup, as the only safe place to park their cash.
With more than 4,000 banks in the United States, consolidation would make the system "stronger, not weaker," Biggar said.
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