Takeaways from First Republic Bank and implications for the US banking system and economy
SUMMARY: First Republic Bank has been taken over by JP Morgan. This may be the last of the significant US bank failures, with First Republic’s stock price collapse an outlier among banks in the last month and the Fed near done with its interest rate hikes. But the broader macro pressures are not over. With steady deposit outflows to higher yielding money market funds pressuring both bank profitability and ability to make loans. Bank lending standards were already tightening, and stepped-up regulatory oversight is on the way. Whilst mid-size banks are especially relevant for commercial real estate and small company lending. This may speed the coming economic slowdown, but also the inflation and interest rate relief.
See previous Explainers on the failures of SVB and SBNY and takeover of Credit Suisse
FIRST REPUBLIC: First Republic Bank (FRC) has been closed by US regulators, the FDIC, and bought by JP Morgan (JPM). The bank will reopen as JP Morgan Chase today. The failure of the US’s 14th largest bank, with $233 billion of assets, is the biggest so far. Three of the four largest US bank failures in recent history have happened since March. The Fed’s initial report into the failure of SVB focused on mismanagement of interest rate and liquidity risks and regulation failings.
LITTLE CONTAGION: The fast and dramatic response in recent months by FDIC, guaranteeing all deposits at failed banks, and Fed, in providing billions in emergency bank funding, has stopped a bank scare from becoming a crisis. Financials is the 3rd largest US stock market sector and bank loans/GDP are 51%. These numbers are higher in the rest of the world. Banks are the largest sector in Europe and loans 92% of GDP.
ECONOMIC IMPACTS. But the macro consequences of the bank’s ‘scare’ remain, and history reminds they can be big and global. Tighter liquidity is slowing loan growth, doing the Fed’s work for it. IMF forecasts this could cut 0.4% from US and Euro GDP growth. More bank regulation and a FDIC ‘special assessment’ is coming. Small cap and real estate lending will be especially impacted.
DEPOSIT OUTFLOWS: The US has $17.2 trillion of commercial bank deposits, equal to 65% of GDP. These saw a pandemic boom but are now falling. Attracted away to money market funds paying up to 4.8% compared to the 0.24% national average bank savings account rate. This will 1) pressure bank profitability as deposit rates are raised, and 2) slow bank lending as liquidity tightens.
CRE AND SMALL CAPS: Small and mid-sized lenders will likely bear the brunt of these issues. This will have particular impact on lending segments where they are disproportionately important. 70% of small caps are clients of the small and mid-sized lenders. Whilst 70% of commercial real estate lending (CRE) is from the same banks.
MORE REGULATION: Tightened regulation is coming for mid-sized banks with assets between $100 and $250 billion. They will likely be required to hold more capital, undergo regular ‘stress tests’ and having ‘living wills’ detailing how they can be wound up if needed. This will come on top of a natural increase in existing regulatory oversight.
SPECIAL ASSESSMENT: The FDIC is required to charge banks a ‘special assessment fee’ to cover losses to its deposit insurance fund. The over $20 billion cost of the SVB and SDNY failures have seen the fund fall below its required 1.35% of insured deposits. Whilst the First Republic failure is estimated to cost the FDIC around $13 billion. This special assessment may be staggered and focused on larger or riskier banks but will be a new drag to sector earnings.
