By Gary Stern
When Silicon Valley Bank and Signature Bank failed in 2023 and had to be taken over by the Federal Deposit Insurance Corporation (FDIC) – the biggest bank failures since the fall of Washington Mutual during the 2008 recession – you’d expect that microcap and regional banks would receive a strong message to get their finances in shape, limit venture debt, reduce commercial real-estate loans and instead strengthen their bottom line.
Signature Bank, for example, collapsed due to a variety of factors including putting too much reliance on volatile cryptocurrency and fluctuating real estate loans.
But the early February quarterly results of New York Community Bancorp (NYSE: NYCB), which acquired much of Signature Bank’s assets, reflect that lessons aren’t always learned in the regional banking industry. New York Community Bancorp reported a loss of $252 million in the latest quarter, despite having grown to 420 branches. The day its earnings were posted, its stock price plunged 38%, which affected the entire slate of regional banking stocks, whose prices fell 6% on average. Several days later NYCB’s stock price plunged nearly 60%.
New York Community Bank attributed much of its losses due to commercial real estate, whose value in large metropolises like New York, has fallen due to many companies relying more on remote workers and shrinking their office space. Indeed, the New York Times reported in early February that its nosedive stemmed from “unexpected losses on real estate loans tied to both office and apartment buildings.”
When Silicon Valley Bank and Signature Bank failed, the message that other regional banks received was quite explicit, “increase liquidity,” noted Taylor Sohns, the CEO of Life Goal Investment, a financial advisory firm based in Saratoga Springs, N.Y., who has written about these issues. “In this day and age when people see a bank is facing stress, the word goes viral quickly, and people run to take out their money. They get scared,” he added.
Some regional banks have gotten the message and started selling some of their assets such as bonds, Sohns noted. “If they fail to build up their liquidity, it endangers them when customers want their deposits returned,” he said.
Regional banks are in a tough spot because many of them have boosted their interest rates on deposits to 2% and 3% or more to lure customers in, while larger banks like J.P. Morgan Chase offer under 1% on deposits, increasing their revenue. “People are fearing the lack of strength of regional banks and that they won’t give me my money bank,” Sohns said.
Banks like New York Community Bank encountered problems because interest rates rose, their costs increased, and their commercial loans weren’t generating enough revenue. If the Federal Reserve cuts interest rates, it would help these regional banks shore up their assets, Sohns noted.
Blair Silverberg, the CEO of Hum Capital, said one message that many regional banks and microcap banks received from the fall of those two banks was they “cannot count on someone to protect their deposits.” So what many of them did, in essence, was to curtail lending, and hide the fact, in some cases, that they weren’t lending at all, which regulators don’t view favorably. Hum Capital, a New York City and Austin, TX-based funding platform, connects private companies looking to raise $1 million to $50 million with institutional investors,
When Signature Bank and Silicon Valley Bank faced some losses that were publicized, its depositors “went on a run, and when that happened the FDIC had to step in,” noted Silverberg.
The FDIC protected the assets, and enabled both banks to be sold and reorganized.
Were he looking to invest in current microcap banking stocks, Silverberg said he would be seeking banks that have a longer lasting relationships with customers. He mentioned what investor and author Peter Lynch, the former manager of Fidelity Investment’s Magellan Fund who wrote Beating the Street, would do to investigate a stock, such as visiting a bank, talking to customers, finding out if they were long-term with the banks to get a better sense of whether they were committed to the bank in a lasting, not fleeting, way.
Hence he says that “regional banks with sticky deposits will prosper” and by “sticky” he’s referring to those long-term relationships that community banks, for example, develop that serve mostly elderly populations in smaller towns. But Silverberg says it can also involve “adding value above and beyond just taking deposits.” For example, he points to Cross River Bank (CSRVF-OTC), which does an excellent job of adding substantial value to its deposit-based income.
By contrast, many of banks and financial platforms that rely on online banking, often have more temporal customers, who can cancel their account in a minute by eliminating the app from their phone. Banks need to help their customers build budgets, invest their money, and develop stronger relationships with customers that are long-term to shore up their assets.
The big lesson that many regional and small cap banks should have learned from the demise of these two banks is “diversification in capital sources is key,” Silverberg noted. Assets shouldn’t only be funded by deposits, but banks need to diversity by setting up funds, investing in private credit funds. “Banks can be good at originating assets, but have to learn to build funds and secure them,” he said.
Yet Silverberg suggests that this might be a favorable time to invest in microcap banking stocks. “Interest rates won’t be going up much more, and when interest rates are down, banks do well,” he noted. He’d also look for microcap banks with diversified sources of income including multiple fee-generating businesses.
So while many regional banks have seen their stocks slide, is this a time to invest in them? As Sohns at Life Goals Investment says, if you do, “You better know what their book of business is” before putting money down on a stock.
DealFlow Events makes no recommendations on whether to buy, sell or hold shares of any particular stock. Investors are advised to conduct their own research and analysis before making an investment decision. Neither DealFlow Events nor any of its affiliates hold any position in the stocks mentioned in The Microcap Newsletter.
