Special Series Part I: Quantifying the Impact of the SVB-Led Banking Crisis

With the Fed raising interest rates by 25 basis points yesterday, a shaky banking sector may be in for much more pain. We used the Omega Point platform with Wolfe Research's US Financials model to uncover the factors associated with strength and weakness in the evolving financial services ecosystem. We also identified large banks, insurance companies, and asset managers with these characteristics. Read on to learn what we discovered.

On March 8th, Silicon Valley Bank announced its unfortunately timed capital raise, which led to a panic amongst its customers, a takeover by the FDIC, a bank rescue package by the Fed, a closure of Signature Bank, and a follow-on rescue of First Republic Bank by a JPM-led consortium.

All of these events happened in just 2 weeks.

Contrast that to the fall of Bear Stearns, Lehman Brothers, and Washington Mutual, which played out over the better part of a year in 2007-2008.

The clockspeed of the financial markets has accelerated.

Investors are already looking past Silicon Valley Bank, Signature Bank, and First Republic to identify the next area of weakness in the banking system and its implications for other financial and non-financial companies.

Omega Point’s role in the investor community is to help bring an unbiased, quantitative lens to an otherwise messy, social-media-fed speculation frenzy on what’s to come. Over the next three weeks, we will help you:

1. Identify the characteristics of banks and, more broadly, the financial services ecosystem that investors associate with a banking crisis.
2. Link these characteristics to the behaviors of non-financial services companies.
3. Build scenarios that allow you to directly test the implications of a banking crisis on your portfolio.

Let’s get started.

Investor Reactions Hold the Clues

In the past two weeks, US Banks and Regional Banks saw a reduction of 22% and 25% in their market capitalization, while broad market indices (S&P500, Russell 3000, Russell 1000) saw comparably muted declines.

From this vantage point, the issues appear isolated to the banking system.

We would all love to think this is an isolated event, at least to make it easier to sleep at night. But it would be helpful to understand better the drivers that would cause a bleed into the non-bank sectors.

We will observe investor reactions within the financial sector to identify those drivers.

Leveraging the Wolfe US Financials model (factsheet available upon request), a sector model built by our partner Wolfe Research, we’ve applied a similar methodology to our analysis of the market reaction ensuing from Russia’s incursion into Ukraine.

In this analysis, we normalized the factor moves in the past two weeks by the expected volatility of the factors. This approach allows us to isolate the factors most sensitive to the events of the SVB-led crisis, as prior investor expectations wouldn’t have considered these events.

The chart below summarizes the top style factors exceeding a 2-standard deviation performance move in the past two weeks.

Wolfe US Financials - Extreme Style Factor Movements: 3/8/2023 - 3/17/2023

All things equal, investors care about financials with stronger fundamentals as defined by higher relative earnings growth, return on assets, and receivables turnover.

Conversely, weaker fundamentals coupled with higher leverage and rate sensitivity are a recipe for panic.

How do These Characteristics Map to the Affected Banks?

It should come as no surprise that SIVB and First Republic exhibited all of the disadvantaged characteristics heading into the March turmoil. Both stocks maintained weaker fundamental exposures with elevated levels of interest rate sensitivity and leverage in the Wolfe US Financials Model.

SIVB’s high exposures to Term Spread and Volatility were the biggest drivers of the stock’s downturn. FRC shared directionally similar characteristics but was most impacted by its underexposure to the Revisions factor as investors dashed out of stocks lacking sell-side confidence. It’s worth noting that both stocks were on the wrong side of all fourteen style factors that experienced multi-standard deviation events.

SIVB security profile

FRC security profile

Which Companies May Bear the Brunt of the Impact?

Now that we understand the positive and negative characteristics of US Financials associated with the banking crisis and their impact on SVB and FRC, we can examine how these characteristics apply to other US Financial companies.

As of March 17th, the universe of US Financials has 458 companies.  

Searching this universe for positive scores across the above fundamental characteristics, we uncover 7 companies (see table below).

Large Financial Services companies with positive fundamental characteristics in the current environment are Global Payments (GPN), Principal Financial Group (PFG), and Regions Financial (RF).

Conversely, if we’re trying to find Financial Services companies with negative fundamental characteristics in the current environment, we find 11 companies.

Large Financial Services companies with negative fundamental characteristics in the current environment are most notably Charles Schwab (SCHW), Ally Financial (ALLY), and Assurant (AIZ).

Building Blocks for the Broader Market Implications

Now that we’ve identified the key fundamental and market characteristics of Financials associated with the recent banking crisis, we have the building blocks needed to formulate how these characteristics map into the universe of non-financial companies.  

Next week, we will conduct this analysis using a broader set of factor models, which should generate some interesting and potentially unexpected insights.

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Regards,

Omer