The seizure and sale of First Republic Bank Monday marked the third bank failure in the United States this year — all in just eight weeks. The failure of highly rated, publicly traded banks has many investors wondering where the next failure is likely to occur.
"These types of episodes unfold gradually, then suddenly," said Andrew Krei, co-chief investment officer at wealth management firm Crescent Grove Advisors.
That makes pinning down potential failures early difficult. Especially considering multiple ratings agencies had First Republic as investment grade as recently as March. Sell-side analysts maintained an average price target of $300 for Silicon Valley Bank stock through the beginning of January, Krei said, citing Bloomberg data.
"More generally, key macro issues have not abated," he said. "And the potential for an economic slowdown over the next 12-24 months could add credit risk to the list of concerns. A cautious approach toward financials seems appropriate against that backdrop."
Banking System Is 'Very, Very Sound' After First Republic
JPMorgan Chase CEO Jamie Dimon told reporters early Monday the banking system is "getting near the end" of its issues. He also said the current situation was nothing like the 2008 crisis.
"The American banking system is extraordinarily sound," Dimon said in a call following the First Republic acquisition. "Obviously, if going forward you have recessions and rates going up and stuff like that, you'll see some other cracks in the system. But that has to be expected. The system is very, very sound."
JPMorgan plans to tweak some of First Republic's business strategies. Dimon doesn't plan on adding mortgages to its balance sheet or offering jumbo mortgages to rich clientele — which was a key First Republic strategy and weakness.
It does plan to rebrand some of First Republic Bank's wealth centers, to integrate its platforms and systems, and tap into the bank's long list of wealthy clients, according to Dimon.
The White House also chimed in to sound an all-clear message for banks.
"Regulators have taken action to facilitate the sale of First Republic Bank and ensure all depositors are protected and taxpayers are not on the hook," President Joe Biden said Monday. "These actions are going to make sure the banking system is safe and sound."
President Biden repeated his calls for stronger regulation and supervision for large and regional banks.
First Republic, Bank Failures In 2023
The bank turmoil started quickly in March. Rising interest rates caused bond prices and hold-to-maturity treasuries to decline. Massive unrealized losses began mounting for bank investment arms that had misjudged the impact of rising interest rates.
Silvergate Capital was the first domino to fall. It announced plans to wind down operations and voluntarily liquidate Silvergate Bank on March 8.
SVB Financial failed on March 10 after announcing massive unrealized bond losses, sparking a deposit run at Silicon Valley Bank. Signature Bank followed quickly and was closed by New York regulators March 12.
The FDIC brokered a deal for New York Community Bancorp subsidiary Flagstar Bank to buy substantially all of Signature Bank's assets on March 19. And First Citizens BancShares purchased all of Silicon Valley Bank's assets and deposits in late March.
They were two different rounds of infusions for First Republic Bank. On March 12, FRC secured $70 billion in liquidity through additional Fed borrowing capacity, funding access with the Federal Home Loan Bank and financing through JPMorgan. Then on March 16 it received a $30 billion deposit injection from the 11 largest banks, led by JPMorgan.
Overseas, UBS Group acquired Credit Suisse on March 20.
Bank Failure History
There were 561 bank failures between 2001 and 2020, collectively holding $721 billion in assets and $522 billion in deposits, Congressional Research Service data shows. Not all distressed banks failed. The number of problem banks identified by regulators peaked at 884 at the end of 2010, representing $390 billion in assets.
The largest bank failure in U.S. history was Washington Mutual Bank in 2008. It had $307 billion in assets and $188 billion in deposits.
Silicon Valley Bank, Signature Bank and First Republic held a total of roughly $548.1 billion in assets and $367.9 billion in deposits, FDIC data shows.
First Republic had approximately $229.1 billion in total assets and $103.9 billion in deposits as of April 13. Silicon Valley Bank, the second-largest bank failure at the time when it folded, had $209 billion in assets and $175 billion in deposits.
Signature Bank had $110 billion in assets and $89 billion in deposits.
As of Q2 2022, there were 39 problem banks with $47.5 billion in combined assets, according to CRS data.
Deposit Insurance Fund
Regulators granted SVB and Signature Bank systemic risk exemptions following their failures. The move lifted the $250,000 deposit insurance cap from the FDIC.
On March 12, the Federal Reserve launched the Bank Term Funding Program. The new program provides eligible banks and other institutions with emergency loans to help "meet the needs of all their depositors."
The Treasury Department made up to $25 billion available from the Exchange Stabilization Fund to backstop the BTFP.
The Next Shoe To Drop?
The biggest risk for banks continues to be the threat of deposits fleeing — either to other banks perceived as safe or high-yielding alternatives like money market funds, according to Crescent Grove's Krei.
But profitability will likely be crimped as banks are forced to raise interest rates on deposit accounts to compete with money market funds. An inverted yield curve, when long-term bonds yields fall below those of shorter term issues, makes the dynamic even more painful, according to Krei.
And if the economy begins to slow, credit concerns will come to the fore, Krei said.
Regulator Failures
The Federal Reserve issued a post-mortem review of SVB last week, highlighting some of its own shortcomings in the bank failures. The Fed and FDIC stated the bank collapses were largely due to mismanagement, according to the reports.
The regulator said supervision relaxed following the 2018 legislative rollback of banking regulations. The Fed noted its resources dedicated to regional bank oversight "proved insufficient."
And its judgments were "not always appropriate" given its weakness. Supervisors considered conducting an interest-rate risk review in 2022 but deferred it to Q3 of 2023 while prioritizing other exams.
The FDIC stated it could have acted sooner and more forcefully to compel Signature Bank management to address deficiencies in its report.
Oversight Changes
Federal Reserve Vice Chair for Supervision Michael Barr wrote the Fed must strengthen its framework for supervision and regulation. Some proposals included multiple scenarios for stress-test modeling. And introducing more continuity in compliance standards when bank portfolios grow in size. Additional tests for banks with $100 billion or more in assets may need to be introduced.
The FDIC recommended lawmakers raise the caps on bank deposit insurance for business payroll accounts to prevent future bank runs.
Representatives on both side of the isle have expressed interest in potential reforms.
"Based on the report and other comments, we expect the Fed will push for greater oversight of small and medium-sized banks and more authority for its regulators to quickly address findings," Krei said.
The Fed acknowledged that the changes will likely take years to implement. But Krei believes the trend will be toward greater regulatory scrutiny of the banking sector now and in the future.
A Successful Response?
If First Republic is truly the last high-profile bank failure, the Fed officials could tout their post-SVB response as a success, Krei said. He cited their emergency liquidity programs, First Republic and JPMorgan deal and minimized contagion risk. The moves "ultimately rescued the banking system from a rash of failures," Krei said.
This episode, and the COVID-era emergency programs, could reinforce the Fed's reaction function and embolden officials to continue acting aggressively in the future, he said.
"Even if First Republic is the last bank to fail in 2023, we see this episode as significant enough to warrant a push for more regulation and oversight," Krei said.
You can follow Harrison Miller for more stock news and updates on Twitter @IBD_Harrison
