Following the government takeover and subsequent sale of First Republic Bank to JPMorgan, bank shares have fallen on Wall Street this week. The loss was the second-largest bank failure in American history and the third midsize lender failure in the previous two months.
While many believed the sale of First Republic “would put an end to the ‘who’s next?’ conversations,'” analysts at UBS observed in a note to clients that “investors are clearly continuing to focus on remaining players that are deemed the weakest.”
The broader concern is that the bank collapses may raise questions about the viability of the other banks, sparking a financial crisis that might affect the entire economy. Following the financial crisis 15 years ago, the United States tightened regulations on major banks in an effort to avoid that disaster.
Although there is no reason to be concerned if you have less than $250,000 in a bank that is guaranteed by the Federal Deposit Insurance Corp., which covers the majority of accounts, it is tough to ignore the anxiety in the banking industry right now.
Regulators and bankers have made valiant efforts to persuade investors that the worst of the crisis is behind us. On Monday, Jamie Dimon, the CEO of JPMorgan, stated that he thought “this part” of the banking crisis was finished. On Wednesday, Jerome Powell, the chairman of the Federal Reserve, affirmed the stability of the financial system.
PacWest Bancorp and Western Alliance Bancorp, two smaller regional banks whose shares have been under pressure since Silicon Valley Bank’s failure in mid-March and the start of the current crisis, were the target of a fresh sell-off on Thursday. Following its admission that it was thinking about selling itself, PacWest’s stock dropped 51%.
Due to a high concentration of big, uninsured deposits from venture capital and technology clients—the same clients that caused bank runs at Silicon Valley and First Republic—PacWest was targeted. According to UBS analysts, the venture capital and technology sectors account for around 23% of PacWest’s deposits.
Even regional banks in the Midwest, including Comerica and KeyCorp, are down more than 20% this week. That might be an indication of growing worries about sizable real estate loans, particularly in the office property market, where the pandemic’s consequences are still being felt.
Both PacWest, with headquarters in Los Angeles, and Western Alliance, with headquarters in Phoenix, released statements overnight claiming that they had not noticed any unusual deposit withdrawals as a result of the sale of First Republic. Following the demise of Silicon Valley Bank, both had substantial withdrawals; but, according to the institutions, deposits have increased since March 31, 2023.
An article in The Financial Times on Thursday morning that said the bank was considering a sale was denied by Western Alliance in a separate statement. Its stock dropped 38%.
Investors might worry that PacWest will end up like First Republic, which spent weeks trying to sell itself but failed. Additionally, First Republic catered to affluent clients, many of whom quickly withdrew their investments when Silicon Valley faltered. The value of substantial loans the bank had made when rates were significantly lower had also decreased as a result of the recent sharp increase in interest rates.
The fundamental problem, especially with these banks, is that they do not have a sustainable asset and deposit mix. Deposits continue to flow out the door, or banks are paying exorbitant amounts for them, according to Chris Caulfield, a West Monroe banking sector consultant who has dealt with many of the struggling smaller banks.
A significant agreement in the banking industry was called off on Thursday, which is another hint of possible trouble. According to TD Bank Group and First Horizon Corp., regulatory obstacles caused them to abandon a planned merger. Toronto-In February, Dominion Bank announced that it will acquire regional bank First Horizon for $13.4 billion in cash.
The Federal Reserve’s battle against inflation has been a major factor in the turbulence in the banking industry. As part of that strategy, the Fed on Wednesday increased its benchmark interest rate by a quarter point to the highest level in 16 years, marking its eleventh straight rate hike.
Depositors have moved their money into money market funds and certificates of deposit that pay greater rates as a result of the increased rates. They also contributed to the tech sector downturn, which had far-reaching effects on West Coast banks like those in Silicon Valley.
In making its next rate decision, the Fed will be keeping an eye on a number of variables, including the instability in the banking industry, according to Chair Jerome Powell.
The Fed chair reaffirmed his conviction that other banks will likely reduce lending as a result of the failure of three sizable banks in the last six weeks, which will aid the Fed in its fight against inflation. Numerous economists anticipate a recession in the latter half of 2023 or in the first quarter of 2024 as a result of the Fed’s recent quick rate hikes, which have started to impede the economy.
Additionally, Powell stated that he agreed with the Fed report’s findings, which concluded that Silicon Valley Bank’s failure was caused by oversight gaps and called for greater banking industry regulation.
According to JPMorgan, among other things, regulatory and economic uncertainties will continue to put pressure on bank stock prices. In a note, analysts stated that “regulatory concerns would mostly translate into how much banks need to add to capital, liquidity, and debt, all of which would strengthen them over the long term but damage (earnings per share).