CITIC Securities Co., Ltd.: The plight of the US banking industry persists, with regional small and medium-sized banks facing another wave of turmoil

According to the information from Zhitong Finance and Economics APP, CITIC Securities released a research report stating that due to the continuous deepening reform of the US financial regulatory framework and environment after the global financial crisis, as well as the timely attention of US regulatory agencies to banking risks since 2023, the probability of systemic financial risks caused by the banking crisis is still relatively low. The bank predicts that if banking risks in the United States erupt, the future trend of the US stock market may be similar to the market performance when Silicon Valley Bank went bankrupt in 2023, mainly influenced by investor sentiment fluctuations; in this scenario, cyclical industry sectors of US stocks will still face significant market correction pressure.

CITIC Securities' comments are as follows:

Dark clouds still looming over the US banking industry, regional banks facing new challenges.

Since 2023, the US banking industry has been plagued by turmoil, with five banks going bankrupt, including Silicon Valley Bank, First Republic Bank, and Signature Bank. However, even as we enter 2024, the storm in the US banking industry has not subsided. In early 2024, financial data released by New York Community Bank (NYCB) triggered deep concerns in the market, leading to a sharp decline in its stock price, further exacerbating the tense situation in the banking industry. The situation for US regional banks is even more worrying, with the decline of ETFs tracking regional banks (KRE) and the S&P 1500 Regional Banks Index significantly exceeding the overall banking industry index, reflecting investors' pessimistic expectations shifting from the entire US banking industry to regional banks.

The US banking crisis remains unresolved, with unrealized losses in securities investments and commercial real estate risks becoming the main issues.

Since the Fed began its rate hike cycle in March 2022, the continuous rise in interest rates has significantly increased borrowing costs for businesses and individuals, impacting the US commercial banking system. As of the first quarter of this year, unrealized losses in securities investments in the US banking industry remained at a high level of $515.6 billion. At the same time, close to half of the banks in the S&P 1500 Banking Index have a high proportion of securities investments in their total assets, and the potential risk exposure from high proportion investments in securities still needs to be monitored. On the other hand, constrained by the high office vacancy rates in the US, the commercial real estate market continues to struggle. In the next two years, up to $1.2 trillion in CRE loans will mature, and the refinancing risks in a high-interest-rate environment cannot be ignored. Small and medium-sized US commercial banks face higher risks due to holding a large amount of CRE loans. According to our sensitivity analysis, if there is a 10% default rate on CRE loans held by US commercial banks, the primary capital loss rate of large commercial banks in the US is relatively low, but the loss rate for small and medium-sized commercial banks could be as high as 24.2%. Therefore, for small and medium-sized banks with large CRE loan risk exposure and high unrealized losses, the outbreak of risks in the commercial real estate market and the impact of unrealized losses on investor confidence could lead to severe capital losses and operational challenges.

Approaching storm: Pressure on US small and medium-sized banks, how will the US stock market interpret?

Under the pessimistic expectations of the National Bureau of Economic Research (NBER), influenced by non-performing CRE loans, the US may face potential bankruptcy risks for as many as 385 regional banks, while over 1700 banks are also within the risk threshold Looking back in history, if this pessimistic scenario were to unfold, the risk process of the US banking industry may be similar to the savings and loan crisis. However, considering that it has been over thirty years since the last savings and loan crisis, if NBER's pessimistic expectations are confirmed, the impact of a US banking industry risk outbreak on the capital markets may be comparable to the global financial crisis of 2008; at that time, defensive industries such as core consumption and healthcare are expected to further highlight their market value, while cyclical industries may face greater market pressure. However, since the global financial crisis, the US financial regulatory system has undergone systemic reforms, enhancing the resilience of the financial system. Therefore, the risk of triggering a systemic financial crisis due to the pressure situation of small and medium-sized banks is still relatively low. Under NBER's baseline expectations, if some small and medium-sized banks do face bankruptcy risks, we expect the market performance of US stocks to be similar to the bankruptcy event of Silicon Valley Bank (SVB) in 2023, with market trends mainly driven by investor sentiment; in this scenario, the market performance of cyclical industries may continue to be under pressure, while the market performance of defensive industries may remain relatively stable.

Risk Factors:

1. The timing of the Federal Reserve's interest rate cuts and global liquidity shifts exceeds expectations; 2) Further escalation of global geopolitical conflicts; 3) US banking industry performance falls short of expectations; 4) Unexpected escalation of risks in US commercial real estate