PacWest Bancorp’s Imminent Demise Shows Bank Turmoil Is Widening To Smaller Banks

The banking turmoil has reached the point where the tide has gone out, and we are seeing which institutions have been swimming naked. A third California-headquartered bank, in less than two months, is looking like it is on the verge of collapse.

As of May 3, PacWest Bancorp’s
PACW
stock has decreased 90% since March 7, the day before Silicon Valley Bank failed. That decline is far more severe than the 34% decline of the S&P Regional Banks Select Industry Index in the same period. And there is no respite in sight for PacWest; when Bloomberg first reported PacWest was looking for a buyer, the stock plummeted more than 55% in a matter of a couple of hours.

With the Federal Reserve’s tenth interest rate hike in 14 months, PacWest and other regional banks are showing they severely underestimated the impact of high interest rates. And even if the Fed pauses its rate hikes, the recent bank turmoil is now headed to smaller banks than the ones that have failed so far. As I mentioned on Bloomberg Surveillance on Monday, it is far from over.

With $40 billion in assets, PacWest is much smaller than Silicon Valley Bank and First Republic Bank
FRC
, both which had $209 billion and $230 billion in assets, respectively, before they failed. While these banks are very different in size, they do have some similarities.

First, all three had very significant asset growth in a very brief period of time. PacWest’s assets grew 58% from 2019 to the end of 2022. Similarly, Silicon Valley Bank’s assets grew 64% in the same time period. Rapid asset growth should always be a warning bell for lenders, investors, and regulators that perhaps a bank is letting go of underwriting standards and may not have the necessary personnel or technological systems to measure the risk of those assets.

Second, these banks had very significant increases in deposits in just a couple of years. From 2019 to the end of 2022, PacWest’s deposits rose 77%. Such a significant increase should always make asset liability managers at a bank test whether those deposits are stable. During the first quarter of 2023, PacWest’s deposits declined 15% in comparison to the same quarter in 2022. Other regional banks also experienced declines, because depositors withdrew funds and placed it in money market accounts to take advantage of the higher rate environment. In the case of Silicon Valley Bank and First Republic Bank, depositors also fled out of concern for the safety of their funds.

Thirdly, these three banks are headquartered in California and regulated by the Department of Financial Protection and Innovation and the Federal Reserve Bank of San Francisco. It is fair to request that these regulators conduct a serious post mortem to find out what risks they may have overlooked or why they did not enforce matters requiring attention or matters requiring immediate attention.

Since last fall, I have been writing that the inflationary impact would impact just about every sector of the economy. Unfortunately, by the time the Fed starts to lower rates, perhaps in the latter half of this year, it may be too late for a number of regional and even smaller banks. They do not have the asset and funding diversity enjoyed by globally systemically important banks. And in this environment, those are the banks that have a higher probability of surviving this turmoil.

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