First Republic earnings resurface banking worries as debt ceiling vote rattles market

A savage first-quarter earnings report from First Republic Bank is rekindling worries about the banking sector at the same time that fears about whether Democrats and Republicans can agree to raise the U.S. debt ceiling to keep the country solvent are rattling markets.

After getting bailed out by a consortium of U.S. megabanks in March at the behest of the Treasury, First Republic reported Monday that revenues and profits were way down and that it would lay off around a quarter of its workforce.

The private-sector rescue of First Republic did little to stanch an outflow of deposits from the bank, which lost 40 percent of the $176 billion in deposits it held at the end of last year. First Republic is now seeking yet more help from the government, other banks and private equity firms to shore up its financial situation, according to a report by the New York Times.

More generally, the public and private rescues of First Republic, Silicon Valley Bank and Signature Bank in March didn’t do much to reassure bank customers who have been turning to other investment methods besides banks, including money-market mutual funds, to get a more solid return on their dollar.

Customers have also been moving their money toward the too-big-to-fail banks, which are benefitting now from a patina of sovereignty that contributed to enormous first-quarter profits. U.S. megabank JPMorgan Chase reported $12.6 billion in profits in the first quarter – more than a 50 percent increase from the first quarter of 2022.

Meanwhile, ratings agency Moody’s has been downgrading numerous regional banks after the Federal Reserve warned of tightening credit conditions during the latest meeting of its interest rate-setting committee.

“There are negative credit implications for the U.S. banking sector that extend beyond immediate funding challenges to downward pressure on banks’ earnings, combined in some cases with weaker capitalization and risks related to commercial real estate (CRE),” Moody’s said.

Fed officials warned about this credit crunch in March saying its effects upon the wider economy would be highly uncertain.

“Participants expected the likely tightening of credit conditions due to the recent developments in the banking sector to further weigh on investment spending. In addition, the banking-sector developments could damp business confidence and increase firms’ caution, reducing their willingness to hire new workers,” the minutes of the March Federal Open Markets Committee meeting read.

Consultants for the banking sector are saying they are seeing increased responsiveness from bankers toward regulators in the aftermath of March’s bank failures, as well as increased demands for information from regulators toward banks.

Bankers get back in touch with their watchdogs

“Banks can look to history to see what’s going to come. Post-2008, there was a pretty hard pullback from regulators and really strict introduction of testing. Some of that’s been clawed back over the last few years, most understandably in the regional smaller bank space,” Dana Twomey of consulting firm West Monroe told The Hill.

“Going forward, some of that is going to come back.”

The bigger picture: Financial watchdogs look for tighter grip on non-banks

Twomey said there were concerns throughout the banking sector and among regulators about banks that have customer bases that are too highly concentrated in a single industry.

The Treasury Department is warning banks about their risk strategy at the moment, telling them they’d better not simply be engines for generating profit at the expense of serving customers and investing in meaningful businesses that serve communities.

The department released its de-risking strategy on Tuesday  — a plan to prevent banks from cutting off access to specific groups of people or industries — which called out profitability as a major factor in making sure the financial sector stays equitable, secure and useful to the real economy.

“The strategy found that profitability is the primary factor in financial institutions’ de-risking decisions,” the Treasury said Tuesday.

The Financial Stability Oversight Council also released last week a newly proposed framework for financial stability risks that looks at a broad range of asset classes and companies including “broker-dealers, asset managers, investment companies, insurance companies, mortgage originators and servicers, and specialty finance companies.”

How bank profits affect the broader economy

Bank profitability correlates to lending patterns throughout the economy. When profits are higher, lending is freer, which helps spur economic activity. But lending also depends on a healthy amount of deposits, which can be affected by interest rates and overall monetary policy. That ratio is called a “deposit beta” and the Fed is paying close attention to it now.

“Funding, in particular stable deposits, has historically been a strength of US banks versus global peers,” wrote Jill Cetina, an analyst with ratings agency Moody’s, in a Friday note.

“Recent events, however, have called into question whether some banks’ assumed high stability of deposits, and their operational nature, should be reevaluated,” she added. “Funding and profitability pressures will be more pronounced for banks that lack a strong deposit franchise and have large holdings of fixed-rate securities and loans.”

Why the debt ceiling is spooking markets

Questions of stability in the financial sector are being asked against the political backdrop of ongoing negotiations about the U.S. national debt ceiling. The stakes here are even higher and threaten a default on federal debt, especially as tax receipts following the filing season that ended on April 18 have been coming in short.

The most dangerous game of chicken: Here’s how the debt limit fight could impact the banking crisis

“The political drama over the Treasury debt limit is suddenly heating up. With April tax receipts coming in weaker than expected, at least so far, it appears that the X-date, when the Treasury will run out of the cash needed to pay the government’s bills on time, may hit as soon as early June. House Speaker Kevin McCarthy’s recent unveiling of proposed legislation to increase the limit is thus none too soon,” Moody’s chief economist Mark Zandi wrote in an April analysis.

Deutsche Bank U.S. rates strategist Steven Zeng puts the U.S. potential default date further back in July or August, under a different scenario.

“It’s true that the previous debt ceiling crises of the last decade were all resolved before the x-date. But investors don’t fully share that confidence right now,” Deutsche Bank analysts wrote in a Tuesday note.