Rising Interest Rates Squeeze Regional Bank Stocks: 'Banks Could Be Forced To Liquidate'

The shocking downfall of SVB Financial Group (NASDAQ: SIVB) has stolen the spotlight in the banking sector this week, but the banking industry's woes may be much more serious than SVB's downfall.

What Happened? SVB shares dropped 60% on Thursday after the bank announced a plan to raise more than $2 billion in capital. The stock plummeted another 45% in early Friday trading on reports its efforts to raise capital have failed and the bank is now exploring a sale before trading in the stock was halted. 

Why It's Important: While SVB may be the poster child for the difficult banking environment, it is far from alone. The Federal Deposit Insurance Corporation (FDIC) estimates U.S. banks have more than $600 billion in unrealized losses generated by rising interest rates.

"Typically, this is not seen as an issue as banks can wait until maturity and thus not realize a loss," CFRA analyst Alexander Yokum said Thursday.

"However, if deposit outflows accelerate, banks could be forced to liquidate securities at a substantial loss, as displayed today by SIVB."

On Thursday, crypto bank Silvergate Capital Corp (NYSE: SI) announced it would be forced to liquidate its assets and wind down its operations, and investors are concerned there could be more victims ahead.

In fact, a number of bank stocks have experienced heavy losses in the last two weeks:

• First Republic Bank (NYSE: FRC) is down 29.6%.
• Signature Bank (NASDAQ: SBNY) is down 21.2%.
• Zions Bancorporation NA (NASDAQ: ZION) is down 13.3%.
• Bank of America Corp (NYSE: BAC) is down 7%.
• JPMorgan Chase & Co (NYSE: JPM) is down 4.2%.
• Citigroup Inc (NYSE: C) is down 5.1%.
• Wells Fargo & Co (NYSE: WFC) is down 7%.

Wall Street analysts see far more risk of contagion among U.S. regional banks than their mega-cap peers.

Bank of America analyst Ebrahim Poonawala said Friday that higher interest rates for longer is bad news for bank stocks.

"While bank stocks could bounce in the short term on macro data that soothes inflation concerns, we believe that the group will struggle to shed the late cycle mindset that has taken hold among investors since last year," Poonawala said.

"We remain biased towards maintaining exposure to the sector via mega-cap banks (over regional banks) given their strong liquidity position, diversified revenue profile and credit defensibility."

Stephens analyst Matt Breese said Thursday that liquidity challenges will drive lower net interest income numbers and weigh on earnings for U.S. banks in the first quarter.

"Upon an eventual Fed pause to IR hikes, we expect investors to shift their focus towards credit quality and therefore, we find it unlikely regional banks will outperform in the near term," Breese said.

JPMorgan analyst Vivek Juneja said Friday that the sell-off in large cap bank stocks could be a buying opportunity.

"We believe the sell-off was overdone as large banks have a lot more liquidity than smaller banks, they are more diversified with broader business models, have a lot of capital, are much better managed in regards to risk, and have a lot of oversight from regulators," Juneja said.

Benzinga's Take: One way for investors to buy the dip in large cap bank stocks while mitigating potential downside risk is via a pair trade. Investors can take a long position in large cap bank stocks with the Invesco KBW Bank ETF (NASDAQ: KBWB) and pair it with a short position in U.S. regional banks with the SPDR S&P Regional Banking ETF (NYSE: KRE).

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