The banking sector has indisputably been under the spotlight in the past couple of months as many big banks from Silicon Valley Bank (SVB) to UBS Group AG (UBS.VX), and Credit Suisse (CSGN.VX) either collapsed and announced their bankruptcy, went under regulatory scrutiny, or were purchased by some of their competitors.
While some may have thought that the worst was over for the banking sector, on Monday, May 1st, it was announced that First Republic Bank which was under regulatory scrutiny for months was acquired by JPMorgan (JPM). What could have led the bank that’s known to cater to the elite and wealthy clients to crumble? Here’s what you need to know about the latest banking sector updates:
Overview: What’s Behind First Republic Bank’s Fall?
First Republic Bank (FRB) certainly had a tumultuous year which was reflected in its recent earnings report on Monday, April 24th. The company’s financial results indicated that its deposit outflows were over $100 billion in Q1 2023.
Many attribute the bank’s woes to its failure to grapple with the Fed’s hawkish interest rate hikes. Experts note that the bank’s poor handling of risk management, huge exposure to interest-rate-sensitive securities, and excessive dependence on non-FDIC insured deposits can be the pitfall that pushed it to its descent.
The reason behind this may be that FRB appears to have made significant investments in long-term assets during a period of low-interest rates. Hence, when the Fed adopted a more hawkish rate-hiking policy to battle record-high inflation, the bank discovered that it was earning less interest from those assets, while simultaneously having to pay higher rates to acquire new funds.
In addition, due to the fact that FRB did not have enough securities that would allow it to borrow funds from the Fed, in March, FRB received a $30 billion lifeline from competitors like Citigroup (C), JPMorgan, Bank of America (BAC), and Wells Fargo (WFC). Nonetheless, despite this lifeline fund, the bank continued to deteriorate up until Monday, May 1st, whereby it was announced that it is acquired by JPMorgan Chase. (Source:Investopedia)
All About JPMorgan’s Rescue Acquisition of FRB
It was announced that JPMorgan Chase, a global leader in investment banking, is going to pay $10.6 billion to the Federal Deposit Insurance Corporation (FDIC), which is the body responsible for maintaining stability in the US financial system, in order to purchase FRB.
The deal would entitle JPMorgan to “substantially all” of FRB’s assets without assuming its debt or preferred stock. In other words, JPMorgan would get $229 billion in FRB’s assets and $104 billion in deposits while the FDIC would recompense JPMorgan for most of the losses incurred on the acquired loans. All in all, the deal to save FRB would cost the FDIC to lose about $13 billion.
How Is the Market Reacting?
Following, FRB’s purchase on Monday, JPMorgan’s stock JPMorgan rose slightly 2.1% hence causing it to be deemed the best Dow stock that day. Other banks like Citigroup and Wells Fargo also rose by 0.3% and 1.5% respectively following the announcement.
What’s Next for the Banking Sector?
This event may have renewed the uncertainty surrounding the banking sector’s future. On the one hand, some may think that the worst is over and behind us. Even JPMorgan’s CEO, Jamie Dimon, stated yesterday in relation to the banking crisis that “this part of the crisis is over.”
On the other hand, however, some are adopting a more cautious tone and even posit that the worst is far from over. Those who think so contend that other regional banks may be suffering from deposits and that the Federal Reserve is expected to hold onto its hawkishness by raising interest rates further. If indeed, these apprehensions hold true and the Fed keeps raising interest rates, then depositors may withdraw their funds, hence increasing the chances of more banking collapses.
Nevertheless, whether or not more banks will be put under pressure remains to be seen. Traders, investors, and consumers alike may want to keep an eye out on the Fed’s 2-day meeting which started today and will end on Wednesday, May 3rd in order to see if more hawkish rates will materialize. As it stands, the market expectations suggest that more rate hikes are on the horizon since inflation still seems to be stubbornly high. Accordingly, the Fed is expected to announce another 25 basis points rate hike, resulting in a range of 5%-5.25% which is the highest level of interest rates since 2007.
In conclusion, the Fed seems to be torn between the need to tame inflation through higher rates and the desire to take a pause on rate hikes. This is because higher interest rates may increase the chances of a recession and add pressure to certain markets including financial stocks. On the flip side, the Fed may need to hike rates in order to manage inflation.