banks

Banks to be pitched to save First Republic with urgency

Jeah Lorraine Adams on June 19, 2023

Banks — In the past couple of weeks, the economy has been bombarded with several problems, namely within the banking system.

Silvergate Bank and Signature Bank collapsed in March, with Silicon Valley Bank joining the fray.

Investors have grown concerned about the situation, inciting panic.

Lender First Republic Bank is on the brink of a collapse, but there could be a way to avoid the situation.

When banks collapse

If banks were to collapse, it would have severe consequences on the financial system and the wider economy.

Firstly, there would be a loss of confidence in the banking system, leading to panic withdrawals and further bank failures.

This could lead to a credit crunch, as businesses and individuals struggle to obtain loans and finance, which in turn could lead to a slowdown in economic activity and job losses.

Governments would likely have to step in to provide support and bailouts to prevent further collapses, which would be costly for taxpayers.

In extreme cases, bank collapses could even trigger a recession or depression, as seen in the 2008 financial crisis.

Another favor

First Republic Bank has a chance of avoiding collapse, and it all boils down to how persuasive a group of bankers can be with another group.

According to reports, First Republic advisors will try to persuade big US banks that have already propped it up for another favor.

Bankers aware of the situation will pitch the US banks to purchase bonds from First Republic at above-market rates for a total loss of a few billion.

Otherwise, they would face over $30 billion in Federal Deposit Insurance Corp. fees when First Republic fails.

Recent developments

The proposal is the latest development in the banking situation after Silicon Valley Bank in March.

After the government seized SVB and Signature, mid-sized banks were hit by heavy deposit runs.

The country’s biggest lenders came together to loan $30 billion in deposits to First Republic.

However, the solution was temporary after the gravity around the company’s problems surfaced.

If the First Republic advisors convince big banks to buy bonds for more than they were worth, they would be confident that other parties would join and help the bank recapitalize itself.

According to sources, the advisors have already listed potential buyers of new First Republic stock.

Urgency

Investment banks are looking to raise the alarm and create a sense of urgency.

This week marks a crucial period for First Republic.

Since Monday, the bank’s stock has been in a free fall after sharing that its deposits recently fell by 41%, which includes big banks’ infusion.

Analysts following the company published negative reports after CEO Michael Roffler refused to take questions after a brief 12-minute conference call.

“Now that the earnings are out, once you’ve got a window to act, it’s time to do it,” said an anonymous banker.

“You never know what will happen if you wait, and you don’t want to be dealing with an emergency situation.”

Sources say that advisors might offer warrants or preferred stock so banks involved can reap part of the upside of helping First Republic, which would help the deal.

False starts

First Republic has always been the envy of other banks due to its focus on rich Americans helping growth and allowing it to lure talent.

However, the model broke down after the SVB failure, with customers pulling out uninsured deposits.

The advantage to the advisor’s plan is that it allows First Republic to offload some of its underwater bonds.

When it comes to government receivership, the whole portfolio must be marked down immediately, which results in what Morgan Stanley analysts estimated to be $27 billion.

However, one problem is that advisors rely on the US governments to bring bank CEOs together to come up with other solutions.

There have already been false starts as one of the top four US banks said the government told it to prepare to act on the First Republic situation in the past weekend.

But nothing happened.

Banks and doubts

While any deal is a matter for negotiation and could have a special purpose vehicle or direct purchases, there are several possibilities that could address the bank’s balance sheet.

On Tuesday, Bloomberg reported that the bank is weighing the sale of $50 billion to $100 billion in debt.

First Republic loaded up on low-yield assets like mortgages, municipal bonds, and Treasuries.

When they loaded up, the bank learned it suffered losses of tens of billions of dollars.

By reducing the size of the balance sheet, the bank’s capital ratios would be healthier, paving the way for it to raise more funds and continue as an independent company.

Other decisions they can take include the conversion of the big bank’s deposits into equity or search for a buyer.

However, a suitor has yet to appear, and it’s unlikely as any buyer would also own the losses on First Republic’s balance sheet.

Sources close to the big banks believe the most likely scenario for First Republic is government receivership.

Those close to the banks were hesitant to endorse a plan that would recognize losses for overpaying the bonds.

They are also doubtful about government-brokered deals following pacts from the 2008 financial crisis leading to higher costs than expected.

The Fed brings up interest rates for the 9th straight week

Jeah Lorraine Adams on March 27, 2023

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The Fed – On Wednesday, the Federal Reserve continued its attempts to combat the high inflation with another rate hike.

This time, they raised interest rates by a quarter point.

Additionally, they addressed risks to financial stability.

The news

Despite the recent meltdown in the banking sector, investors and economists were wary of a potential quarter-point increase.

Federal Chairman Jerome Powell and legislators went into their second policymaking meeting of 2023 with an air of uncertainty due to the shifting landscape around the financial system.

In the past few weeks, the Fed’s initiative to bring down inflation had become difficult as several banks collapsed.

The situation led to the Fed working to balance a potential financial crisis as inflation continued to soar, and the labor market tightened.

A struggle on all fronts

When the meeting concluded, the Federal Reserve released a statement acknowledging the recent financial market dilemma was taking a toll on inflation and the economy.

However, officials expressed their confidence in the overall system.

“The US banking system is sound and resilient,” they wrote.

“Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation.”

“The extent of these effects is uncertain.”

According to the officials, the Committee is still keeping track of the inflation risks.

The banking crisis

The recent banking troubles have instilled fears across the country.

Many fear that the central bank might overcorrect the economy and potentially lead the country into a recession.

Others are afraid that their actions could trigger more bank failures.

Meanwhile, prominent economists have urged the Federal Reserve to hit the brakes on the rate hikes.

Their calls for a pause can be partly attributed to rate hikes undermining the value of Treasuries and other securities, which have always been a critical source of capital for most US banks.

For example, when Silicon Valley Bank had to sell bonds quickly at a substantial loss, it went through a liquidity crisis that led to its collapse.

Former New York Fed President Bill Dudley offered his two cents, saying, “The Fed’s in a bit of a bind.”

“On the one hand, they should keep tightening because inflation is still too high and the labor market is too tight.”

“On the other hand, they want to make sure they don’t do anything to exacerbate the stress on the banking system.”

“There’s not really a right solution.”

The rate hikes

Policymakers have made their decisions, and interest rates have increased for the ninth consecutive time.

They raised overnight lending rates to the highest level since September 2007, going from 4.75% to 5%.

Their actions send a clear message that right now, their top priority is restoring price stability.

It’s also important to note that the decision to raise rates by a quarter point was in complete accord.

Since June 2022, no policymaker has been against the decision for other similar decisions.

Additionally, they released their rate projections after their last release around December.

Projections have primarily aligned with previous forecasts.

Furthermore, the Federal Reserve is still anticipating more rate hikes as they expect interest rates to reach 5.1% by the end of the year.

With this in mind, the Feds expect another quarter-point rate hike before they decide to hit the brakes.

However, officials indicate that interest rates would likely stay high longer while they bring their projected Federal funds rate from 4.1% to 4.3% in 2024.

In March, Jerome Powell hinted that interest rates could move higher and remain there longer than previously anticipated.

With the current financial conditions, there might be less need to hold the rates higher to cool the economy and curb inflation.

Fed officials are projecting deeper economic cuts in the next two years.

Real GDP is a measure used for the economy, and it is forecast to grow by 0.4% in 2023, which is a step down from previous projections of 0.5%.

In 2024, officials anticipate the economy will grow by 1.2%, lower than the 1.6% expected in December.

Furthermore, Fed policymakers forecast unemployment dropping lower than expected by the year’s end – 4.5% from the earlier 4.6% in December.

However, inflation could go higher than expected.

Fed officials are projecting PCE inflation could go higher this year than the last forecast, from 3.1% to 3.3%.

Bank stocks have become a prospect amid recession fears

Alice Blake on March 16, 2023

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Bank stocks – Experts estimate that major economies will either slow down or fall into a recession.

As a result, investors today are abandoning tradition in 2023, piling into major bank stocks.

Between January and late February, the Stoxx Europe 600 Banks index, consisting of 42 major European banks, climbed by 21%.

It hit a five-year high, outperforming the Euro Stoxx 600, its broader benchmark index.

Meanwhile, the KBW Bank tracks 24 of the leading US banks, and it rose by 4% in 2023, slightly outpacing the broader S&P 500.

Following the lows last fall, the two bank-specific indexes have surged.

The economy

However, the economic picture is less encouraging.

The United States and the European Union’s biggest economies are projected to grow sluggishly compared to last year.

Meanwhile, the UK output is expected to decrease.

According to former Treasury Secretary Larry Summers, a sudden recession at some point is risky for the United States.

However, central banks were forced to raise interest rates following the widespread economic weakness coinciding with high inflation.

Regardless, it has been a bonus for banks, allowing them to make larger returns on loans to households and businesses as savers deposit more money into their savings accounts.

While rate hikes have anchored big banks’ stocks, fund managers and analysts said that great confidence in their ability to endure economic storms after the 2008 global financial crisis has also played a role.

“Banks are, generally speaking, much stronger, more resilient, more capable to [withstand] a recession than in the past,” said Roberto Frazzitta, the global head of banking at Bain & Company.

Interest rate increases

Last year, policymakers launched campaigns against the increasing inflation as interest rates in major economies increased.

The steep hikes followed a period of low borrowing costs that began in 2008.

The financial crisis ruined economics, prompting central banks to slash interest rates lows to incentivize spending and investment.

For more than a decade, central banks barely budged.

Investors don’t typically bet on banks in an environment where lower interest rates typically feed into lower lender returns.

Thomas Matthews, a senior markets economist at Capital Economics, said:

“[The] post-crisis period of very low interest rates was seen as very bad for bank profitability, it squeezed their margins.”

However, the rate hiking cycle from 2022, coupled with a few signs of easing up, changed investors’ calculations.

On Tuesday, Fed Chair Jerome Powell said interest rates would rise higher than anticipated.

Returning investors

Due to the higher potential shareholders’ returns, investors have been drawn back.

For example, Ciaran Callaghan, the head of European equity research at Amundi, said the average dividend yield for European bank stocks is currently at around 7%.

According to Refinitiv data, S&P 500’s dividend yield currently stands at 2.1% while Euro Stoxx 600 is 3.3%.

Additionally, European bank stocks rose sharply in the past six months.

Thomas Matthews attributed Capital Economics’ outperformance to US peers based on how interest rates in the countries using euros are closer to zero than in the United States, which means investors have more to gain from the increasing rates.

He also noted that it could be due to Europe’s remarkable reversal of fortune.

Wholesale natural gas prices in the region hit a record high last August, but they have since tumbled to levels prior to the Ukraine war.

“Only a few months ago, people were talking about a very deep recession in Europe compared to the US,” said Matthrew.

“As those worries have unwound, European banks have done particularly well.”

Structural changes

Right now, European economies are still weak.

Whenever economic activity slows, bank stocks are challenging targets to hit due to banks’ earnings ties to borrowers’ ability to repay loans and satisfy consumers’ and businesses’ appetite for more credit.

However, unlike in 2008, banks are better positioned to endure loan defaults.

Following the global financial crisis, regulators proactively set up measures, requiring lenders to have a sizable capital cushion against future losses.

Lenders must also have enough cash (or assets that can be quickly converted) to repay depositors and other creditors.

Luc Plouvier, a senior portfolio manager at Dutch wealth management firm Van Lanschot Kempen, noted that banks underwent structural changes in the past decade.

“A lot of the regulation that’s been put in place [has] forced these banks to be more liquid, to have much more [of a] capital buffer, to take less risk,” he noted.

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