As we approach the two-year anniversary of the brief banking industry crisis of Spring 2023, we wanted to reflect on what happened and how we responded to those events. 

As a reminder, several bank management teams made the mistake of having a high concentration of uninsured deposits and large bond portfolios with significant unrealized losses. This toxic combination received heightened attention following the failure of Silvergate and an ill-managed capital raise by Silicon Valley Bank. Given the speed at which deposits can flee compared to past crises, bank runs can materialize almost instantly. Following the failure of Silicon Valley Bank, regulators erred in not initially backstopping deposits before reversing themselves when the contagion began to spread.

In the weeks that followed, we worked aggressively with bank management teams to accurately assess what was happening. Two of our analysts attended a bank conference within weeks of the crisis to observe and analyze the reality on the ground. We came away comfortable with the conclusion that the contagion appeared contained.

From there, we quickly increased our bank weighting in both strategies when we saw that valuations were disconnected from fundamentals—a correlation central to our contrarian investment philosophy. We were rewarded for this decision when the KBW Regional Banking Index (“KRX”) outperformed the Russell 2000 Value (“RUJ”) 54% to 32% from the date of the aforementioned conference through the most recent year-end.

While banks have performed well since the 2023 panic, valuations have modestly increased,  remaining well below historic levels. With the industry benefiting from deregulation, balance sheet expansion, and wider net interest margins, earnings growth may serve as a tailwind to drive further outperformance in the months to come.

Sincerely,

Pacific Ridge Capital Partners