“We’ve covered the bank sector for over two decades and we have never seen the industry come together before to help secure a peer in need,” J.P. Morgan analyst Steven Alexopoulos said on Friday.
Alexopoulos was referring to the surprising decision by 11 of the largest banks in the United States to deposit $30 billion into their smaller rival, First Republic Bank.
First Republic was on course to become the next domino to fall after three other medium-sized regional banks failed last week. But this week’s support from banks that are technically its competitors seems to have staved off an immediate collapse in the San Francisco-based firm.
On Thursday, as rumors of the support began to proliferate, the SPDR S&P Regional Banking ETF (KRE) jumped 3.5%. But on Friday, once investors got a chance to pore over the details of what the big banks were offering, that enthusiasm faded.
KRE was down 5.4% as of midday Friday, sending its month-to-date losses to 29%.
Investors’ initial enthusiasm may have come from the obvious—some of America’s largest banks were willing to put their own money into another bank that is now at the heart of the crisis that is gripping regional banks.
The $30 billion worth of deposits will pay market rates, and crucially, they are uninsured, just as most of First Republic’s other deposits are.
By putting their cash into First Republic, the big banks seem confident that either First Republic will survive—at least for the next 120 days over which they’ve committed to deposit their funds—or that even if First Republic goes under, the government will backstop the uninsured deposits, just as they did in the case of Silicon Valley Bank and Signature Bank last weekend.
Indeed, the government’s involvement in bringing this deal together suggests there is an implicit guarantee on First Republic’s uninsured deposits, something that may help stem deposit outflows from the bank.
Still, some analysts were concerned that by receiving this support, First Republic revealed just how dire its situation is.
“Prior to this event, we did not know for sure if First Republic had indeed experienced a true run on the bank, or that perhaps the bank would be able to maintain its deposit base relatively intact. Disclosures made by First Republic regarding this latest liquidity injection remove all doubts that a significant runoff of deposits has occurred,” Morningstar strategist Eric Compton said.
Analysts at Jefferies estimated that depositors may have taken $89 billion out of First Republic over the past few days—a massive sum for a bank that had total deposits of $176 billion at the start of the year.
On the positive side, First Republic said on Thursday that daily deposit outflows “have slowed down considerably.”
Meanwhile, other analysts questioned what swapping low-cost deposits for higher-cost deposits (as well as other high-cost sources of funding) could mean for First Republic’s earnings power and its ability to survive as a stand-alone entity.
Analysts at Wedbush Securities Inc. say that First Republic shareholders would likely lose everything in a takeover of the bank, while J.P. Morgan’s Alexopoulos believes the bank can continue to thrive even with a much smaller deposit base. He has a $62 price target on the firm.
The mixed read on First Republic’s financial health is a microcosm of the uncertainty that surrounds the broader regional bank industry and regional bank ETFs like KRE.
An ETF that has lost nearly a third of its value in two weeks could be a bargain if fundamentals revert to what they were prior to the collapse of Silicon Valley Bank.
But that would first mean stopping the crisis in its tracks.
That’s why First Republic is so important. After Silvergate Bank, Silicon Valley Bank and Signature Bank went down, the government took forceful actions to stem the panic.
If another bank fails even after all of that, it could spark chaos, leading to massive outflows from small and medium-sized banks into the “too big to fail” mega banks, leading to sharp contraction in lending activity.
That’s why the big banks and the government took such forceful actions to prop up First Republic. Competitor or not, a full-blown banking crisis—which would likely be followed by full-blown recession—helps no one in the industry.
The next few weeks will be crucial in determining whether the actions taken thus far—from the implicit guarantees on uninsured deposits, to the Fed’s new lending facility to the latest liquidity infusion into First Republic—have done enough to stem the panic.
That in turn will play a large part in determining the fate of the regional bank ETFs.
Email Sumit Roy at [email protected] or follow him on Twitter @ sumitroy2