This analysis is by Bloomberg Intelligence Senior Analyst Herman Chan and Associate Analyst Sergio Ferreira. It appeared first on the Bloomberg Terminal.
Though bank resolutions have worked as intended with stronger entities acquiring failed institutions, market negativity can destabilize even well-regarded banks like First Republic. A litany of headwinds include deposit instability, rising funding costs, inadequate capital and increased regulation. A credit downturn is looming, with particular weight on office exposures.
Giving back rate benefits as deposits reprice higher
Deposit betas are expected to rise quickly following the recent banking turmoil as clients become more aware of higher-yielding alternatives. Most regionals offered a dimmer view for deposit repricing during their 1Q earnings reports. We highlight Comerica and Zions, which kept betas low in 2022 by allowing deposit runoff. These two companies now anticipate terminal betas reaching around 50%.
Beta expectations have been a moving target somewhat as estimates continue to worsen. For example, KeyCorp lowered its outlook to low-40% from the mid- to high-30% forecast in early March, which was weakened from the mid- to high-20% anticipated after 4Q. Regions and M&T, with historically strong deposit franchises, left their beta assumptions unchanged.
Capital base faces more scrutiny after failures
Banks face renewed capital scrutiny with regulatory changes expected after the collapse of SVB and Signature, particularly the three largest regionals U.S. Bancorp, Truist and PNC. U.S. Bancorp has historically targeted a lower capital base due to its solid profitability and conservative credit quality, but its CET1 has been dented due to the 4Q MUFG Union deal. With unrealized losses in available-for-sale securities likely returning to large regionals’ capital calculations, U.S. Bancorp’s adjusted CET1 ratio looks light at 6.5%, below its 7% requirement. It has time though before new regulations begin, and strong earnings power and paused share buybacks should give capital a lift.
Truist’s CET1 has also fallen due to deals, but the partial spinoff of its insurance business will boost the metric by 32 bps in 2Q.
Banking turmoil exacerbates deposit attrition
Deposit outflows accelerated in 1Q after the failures of SVB and Signature, while balances are showing signs of stabilization at Western Alliance, which noted 2Q deposits were up $2 billion through April 14. First Republic, Western Alliance and Comerica had the weakest deposit results as the sector fallout spurred outflows from these banks’ high-net-worth depositors and tech companies sought sanctuary at larger competitors. First Republic faces a tough road ahead as it’s much more reliant on costlier funding after a 41% drop in deposits in 1Q.
Loan growth, up 0.8% at the median, slowed amid deposit attrition. Truist highlighted tighter credit underwriting, while Regions noted moderating loan pipelines. Client demand may be declining as well. Huntington expects softer capital spending.
What’s at stake for regional banks?
Capital, liquidity rule changes.
Banks with more than $100 billion in assets will likely face higher capital requirements, tougher liquidity coverage ratios and harsher stress testing in response to Silicon Valley Bank’s failure. Though a 2018 law raised what is known as the systemically important financial institution (SIFI) threshold from $50 billion to $250 billion, the Fed does have the authority — via a rulemaking — to reapply enhanced prudential standards to those above $100 billion. We maintain, based on a Fed report released on April 28, that banks currently with $100 billion to $250 billion in assets may face approximately the same regime as those above $250 billion now confront.
Office exposure gains more urgency
Banks’ office exposure has been an area to watch considering rising vacancy rates and weaker cash-flow prospects for borrowers due to the work-from-home phenomenon, but recent developments could add more scrutiny. The market’s dim view of paper losses in held-to-maturity securities and low-yielding residential mortgage loans made during the pandemic is beginning to shift office commercial real estate exposure, another area where the fair value of the asset is presumably below the carrying value.
In sizing exposure across regional banks in our coverage, disclosures are spotty at the moment. For those that disclose, office concentration is relatively low, at a median 13% of total commercial real estate. Bank OZK has the highest CRE exposure at 70%, but the bank has a lengthy history in managing credit risk.
Bloomberg
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