Over the last few weeks, we saw California’s PacWest (Pacific West) Bank weighing a sale (the company has seen its stock price drop more than 72% in 2023) and we watched as California’s state bank regulator shut down First Republic, making it the fourth bank to shutter in recent months. This has all of us wondering: Are more mergers coming to the banking industry? Thankfully, First Republic was quickly sold off to JP Morgan Chase, with the FDIC as receiver. As the Wall Street Journal explained it, First Republic was a victim of the Federal Reserve’s attempt to slow inflation with ever-higher interest rates. As rates climbed, First Republic depositors sought better returns elsewhere. The bank couldn’t afford to match paying out higher rates because the Fed’s rising rates were crushing the bank’s portfolio of mortgages.
It’s a conundrum: the Fed raises rates to fight inflation…But then mid-size banks can’t keep up, so they lose depositors, regulators shut them down, and then mega-banks (like JP Morgan Chase) become even bigger.
READ MORE: Is My Money Safe? Real Answers For What’s Happening At U.S. Banks
The ongoing question here is really whether slowing inflation and a halt to further rate increases will give these smaller banks a chance to balance their books — or whether more banking industry mergers may be coming. To get answers for you, we spoke to two banking sector experts: Ken Tumin, senior industry analyst at LendingTree, and Bankrate senior economic analyst Mark Hamrick. Neither of them see mergers in the banking industry stopping anytime soon.
“There has been a long industry trend of consolidation among community banks and credit unions,” Tumin says. “That trend may accelerate in 2023 as high interest rates stress weak banks and credit unions.”
It’s very common for the FDIC to arrange for large banks to acquire failed banks, Tumin explains. Hamrick even likens it to a “shotgun wedding,” where the big banks don’t really have much choice in the matter, adding that if the Federal Reserve goes through with tightening regulation of mid-sized banks, that could “compel further consolidation so that the affected enterprises would attain further scale.” In other words, the big banks may just keep getting bigger.
What does the failure of First Republic say about inflation or a looming recession?
Unfortunately, inflation and recession are inexorably linked. To combat the former, you risk the latter. The Fed is trying to find a balance that’s “just right,” a bit like Goldilocks tasting the three bears’ porridge, looking for the perfect interest rate bowl.
“High inflation in the last year has led to higher interest rates and that contributed to the failure of First Republic Bank — and is stressing the banking sector,” Tumin says. “That is causing tighter credit conditions, which is increasing the odds that a recession will occur.”
Hamrick is a bit more optimistic, and is listening closely to Federal Reserve Chairman Jerome Powell. “As Powell has said, the expectation of tighter lending arising from the failure of Silicon Valley Bank — which had already begun before the failure — may end up doing some of the central bank’s work, in slowing the economy,” he explains.
While a Bankrate survey of economists still puts chances of a recession this year at about 2-in-3, Hamrick adds that “the economy has proven more resilient than many might have expected, with the unemployment rate still low, but likely set to rise. If a more severe recession were to emerge, then more disruption would be expected. Right now, severe is not the base case.”
So, what are the most important things in the banking sector that savvy investors (and consumers) need to keep in mind right now?
“With more bank failures likely to occur, consumers should keep their deposits under the FDIC coverage limits at their banks,” Tumin says. “Investors should understand that the stock price of a bank can get wiped out if regulators close the bank.”
In the past month, stock in First Republic Bank, for instance, dropped around 75%. But even though the bank was “failing,” Chase’s purchase of First Republic may have been a win for Chase, which saw its stock rise on news of the buyout. As Barron’s noted, Chase paid 87 cents on the dollar for First Republic’s assets and its assets were $18 billion more than its liabilities. Even with Chase owing a payment of $10.6 billion to the FDIC, that’s a net gain of billions.
So, investors in JPM Chase should be pleased. As for all other investors, Hamrick says we’ll all be pleased to have resolution to two major questions in the coming months: If the Fed is getting any closer to ending its tightening cycle, and when might it begin cutting rates.
The answer to those questions will go a long way to determining if a recession will be avoided and when earnings outlooks will begin to improve. And of course these questions aren’t just relevant to investors — they’re also of paramount importance to workers since “the strength of the job market will also be key, and very much related,” Hamrick says.
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