Is the worst of the banking crisis over? It may seem like a strange question to ask so soon after the collapse of the First Republic Bank, the second-biggest failure in U.S. history, but many industry experts say the problems were unique to the once high-flying lender. .
Investors seem to share the same view: While First Republic was collapsing and stocks plummeted, financial markets were much calmer than in mid-March, when the defaults of Silicon Valley Bank and Signature Bank sparked a panic that swept the industry. .
First Republic was seized by regulators early Monday morning and sold to JPMorgan Chase. The S&P 500 stock index barely moved in trading and shares of JPMorgan gained about 2 percent. The declines in shares of much smaller banks, shaken by the March turmoil, have been relatively subdued.
Following the failures of Silicon Valley Bank and Signature Bank, First Republic collapsed after depositors and investors left the institution, raised their money and sold their shares en masse. The woes also included huge real estate loans that quickly lost value as interest rates rose and a concentrated customer base of wealthy savers who quickly withdraw large amounts of money.
Many banks continue to face difficult economic conditions, but no other leading lender seemed to face a similar set of pressing challenges. That was underlined in recent weeks as dozens of regional banks reported their first-quarter results, providing a less stark assessment of their outlook than many investors and analysts had feared.
“The problems at First Republic were already visible on March 10,” said Nicolas Véron, a senior fellow at the Peterson Institute for International Economics, referring to the day Silicon Valley Bank collapsed. “For me, this is just a holdover from the previous episode. The only surprise here is that it took so long.”
First Republic lost $102 billion in deposits in the first quarter, but withdrawals from other banks stabilized much faster. PacWest Bancorp, a Los Angeles lender, lost nearly $6 billion in deposits during the quarter, but by the end of March, the outflow had reversed, according to executives. Western Alliance, an Arizona bank also under scrutiny, added $2 billion in deposits in the first half of April.
KBW’s regional banking index, an index of smaller regional lenders in the United States, lost little ground even as First Republic’s shares plummeted, signaling that investors saw First Republic as a problem in its own right, rather than a a harbinger of more trouble to come. That’s a message many bank executives have also tried to convey as they distanced themselves from their stricken rivals.
It’s a very different reaction than investors had in March. After the sudden collapse of Silicon Valley Bank, banking indices collapsed, sending the broader stock market tumbling amid fears of a credit crunch and a spiraling economic crisis. In the weeks since, including the first trading session since First Republic’s demise, the S&P 500 has rarely faltered, bringing First Republic’s problems into sharper focus.
Banking analysts say there are no other major banks as visibly on the brink as First Republic, and they deem it unlikely that there will be any other major government takeovers in the coming weeks. That said, banks still face a lot of risk.
Rising interest rates are a blessing and a curse for financial institutions: Banks can earn more from the loans they make, but they are under greater pressure to offer higher interest rates to encourage savers to keep their money where it is. “We are going to pay more for our funding this year than we thought,” Bruce Winfield of Saun, the CEO of Citizens Financial Group, told analysts on April 19, echoing a common refrain among bank leaders.
The biggest gap that threatens regional banks is in their commercial real estate portfolios. Medium-sized banks are the country’s largest lenders for projects such as apartment buildings, office towers and shopping malls. Higher interest rates put pressure on that market.
More than $1 trillion in commercial real estate loans will mature before the end of 2025, and as banks tighten their underwriting commitments, many borrowers may struggle to refinance their debts. Regulators and analysts will be watching to see if those challenges expand into a wider economic problem.
Vacant office buildings are a particular pain point: vacancy rates are rising across the country and new construction is declining as the industry adjusts to how remote working may have permanently changed the demand for office space. Commercial real estate loan default rates are creeping up, though they remain well below the peak of the pandemic.
Credit rating agency Moody’s downgraded 11 regional banks in April, citing exposure to commercial real estate and “the implications of home-working trends” in the office market as reasons for its gloomy outlook on the banks’ outlook.
The average bank has about a quarter of its assets tied up in real estate loans. Rising interest rates have left thousands of banks with loans and securities that have fallen in value. If commercial real estate foreclosures increase significantly, hundreds of banks could find themselves in a position where their assets are worth less than their liabilities, according to Tomasz Piskorski, a Columbia Business School professor who specializes in real estate finance.
In a new working paper, based on research not yet peer-reviewed, Dr. Piskorski and his co-authors that dozens of regional banks could be in serious trouble if their real estate portfolios fell in value and their uninsured depositors became frightened and fled.
“This is not a liquidity problem, it’s a solvency problem,” said Dr. Piskorsky in an interview. That doesn’t mean those banks are doomed — insolvent lenders can survive if they’re given time to recover and absorb their losses. But it leaves those institutions vulnerable to bank runs.
The Federal Reserve has loan programs to help troubled banks, including one set up last month that offers banks loans against certain distressed assets at their original value. Dr. Piskorski thinks this is a good short-term intervention, but remains concerned about the consequences later this year if economic conditions deteriorate.
“The signals are not necessarily encouraging“ he said, citing additional dangers such as slowing job growth and the near-frozen housing market. “These are not very favorable conditions for the banking systemS.”
In addition to the pressure smaller banks will face in the coming months and years, analysts expect tighter supervision by regulators and eventually new rules. Three government reviews released on Friday highlighted regulatory sluggishness and failures that allowed Silicon Valley Bank and Signature Bank to grow despite clear signs of trouble.
This will probably lead to banking supervisors more quickly identifying – and correcting – problems that could cause unrest for banks. “Opposition from the banking industry probably won’t make much of a difference this time around,” said Ian Katz, general manager of Capital Alpha Partners, a Washington-based research firm. “The wind is at the regulators’ backs to do something.”
For now, any immediate contamination from First Republic appears to be under control. “From the beginning, when Silicon Valley started to collapse, the screens were run and the weak players were identified,” said Steve Biggar, an analyst reporting on JPMorgan at Argus Research. “I think First Republic’s conclusion should allay a lot of the concerns about the banking crisis at this point. All these banks are now in stronger hands.”
Emily Flasher reporting contributed.
