Investors are Waking Up to New Reality of Bank Stress, World Markets On Edge

Barry Adams
17 Mar, 2023
New York City

The U.S. bank system stress is finally getting some attention on Wall Street. 

Investors are dealing with a new reality that the Federal Reserves' aggressive rate hikes are having impacts in the banking sector, a set of conditions not experienced by investors and bank executives for decades. 

Rapid increases in interest rates have battered most portfolios of banks, especially those including U.S. Treasuries of longer maturities, 10-years and beyond.

Granted these are unrealized losses, but with every basis point increase in rates, bond prices are falling to adjust the new higher yield. 

And with that comes higher stress in securities held by banks. For the last three decades banks have dealt with all kinds of problems, but none created as many challenges as the rapid hikes in rates in 2022.

What impact these banks will face will depend on how much of the bank's assets are in long-dated U.S. Treasury securities, but not a single bank will be able to escape unscathed from these losses. 

This fast evolving interest rate crisis has worried regulators for years, but no one expected inflation to surge to a 4-decade high and sequential multiple large-sized rate hikes that followed. 

The pledge by top banks to provide deposit infusion failed to impress investors and regional banks accelerated losses for the third day this week.  

The largest 11 banks on Thursday pledged to deposit $30 billion for the next 120 days only with First Republic Bank, the move was partly driven by self preservation. 

Big bank's move was orchestrated by the FDIC, Federal Reserve, U.S. Treasury and Office of Comptroller in an effort to revive the flagging support and prevent a run on the bank before it happens and avoid the perception of a government bailout.  

Despite the announcement, First Republic Bank plunged 20% after investors looked for details on how and how much interest rate the bank will pay on these new deposits. 

The joint statement from the eleven banks is short on details. 

First Republic Bank said in a filing with the Securities and Exchange Commission "on March 9, 2023, the bank has also increased short-term borrowings from the Federal Home Loan Bank by $10 billion at a rate of 5.09%."

The California bank is in discussion with several banks and other private equity funds in reviewing its options including sale of the company.

In Friday's trading, size of the bank did not matter and large and mid-sized banks declined amid lingering concerns about the health of the U.S. banking system. 

JPMorgan Chase, Wells Fargo, Bank of America, PNC Bank, US Bancorp and Truist financial Corp declined between 3% and 7%. 

U.S. banks are sitting on $620 billion of unrecognized losses as of the end of 2022, reflecting a 28% loss of unrealized equity capital in the banking system. 

Moreover, in the first quarter of 2023, the yields on Treasury bonds have risen, generating additional losses for banks of all sizes holding long and short-dated U.S. Treasury securities. 

If the Federal Funds rates are increased to 6%, total unrealized equity capital loss across all banks could rise to 50%, effectively endangering the entire U.S. banking system. 

The rapid collapse of Silicon Valley Bank is raising questions about how prepared banks are in facing swift departure of bank deposits in the world of online banking. 

Silicon Valley Bank lost 25% or $42 billion of deposits in less than eight hours, after a bank run was started by the venture capitalists community. 

 

Indexes & Yields 

The S&P 500 index decreased 1.1% to 3,916.64 and the Nasdaq Composite index dropped 0.7% to 11,630.51.

The yield on 2-year Treasury notes inched lower to 3.86%, 10-year Treasury notes to 3.44% and 30-year Treasury bonds dropped to 3.63%. 

Crude oil price for immediate month delivery decreased $2.04 to $66.31 a barrel and natural gas price fell 16 cents to $2.34 a thermal unit.

 

U.S. Stock Movers  

First Republic Bank declined 32.7% to $22.06 despite 11 largest banks pledged to deposit $30 billion in the embattled bank in a show of support and prevent a run on the bank. 

Western Alliance Bancorp dropped 15% to $31.38, Zions Bancorporation fell 6.7% to $29.94 and KeyCorp declined 6.1% to $11.57. 

FedEx Corp increased 7.9% to $220.34 after the parcel delivery company revised higher its fiscal year outlook. 

Revenue in the quarter ended in February declined to $22.2 billion from $23.6 billion and net income fell to $771 million from $1.1 billion and diluted earnings per share dropped to $3.05 from $4.20 a year ago.  

The parcel delivery company completed a repurchase of 9.2 million shares in the fiscal third quarter. 

The company lifted its fiscal year 2023 diluted earnings per share forecast in the range of  $13.80 to $14.40 before the mark-to-market retirement  plans accounting adjustments, compared to the prior forecast of $12.50 to  $13.50 a share. 

The company estimated fiscal year capital spending of $5.9 billion. 

 

European Markets Extend Weekly Losses On Bank System Worries 

Rapid rise in rates has created a new scenario not experienced for decades and investors are questioning how many banks are strong enough to digest accumulating losses in the assets held by financial institutions. 

With the rates advancing from negative to 3% and expected to reach as high as 5% before the end of 2023, large and small banks and insurance companies will be forced to deal with large losses in government securities. 

U.S. banks have accumulated unrealized losses of $620 billion, about 28% of its equity capital as of end of 2022. 

Rates are still rising in the U.S. and unrealized losses are expected to grow to as much as 50% of the equity capital, endangering most financial institutions. 

In Europe, banks turned lower on the worries of large losses at banks and looming economic slowdown also dented market sentiment. 

Investors were on defensive after the statistical office confirmed the elevated inflation in February. 

 

Euro Area Inflation Edged Slightly Lower In February 

The inflation rate in the Euro Area edged slightly lower in February from January but the rate was significantly higher than a year ago, the latest update from Eurostat showed. 

The Harmonized index of consumer prices or HICP on an annual basis increased 8.5% in February, slightly lower than 8.6% in January. The index increased 5.9% in the month a year ago. 

The final read on the inflation measure matched the preliminary estimate released on March 2. 

Core rate of inflation, which excludes energy, food, alcohol and tobacco products, accelerated to 5.6%, matching the flash estimate, from 5.3% in January.  

 

Indexes & Yields 

The DAX index fell 1.3% to 14,768.20, the CAC-40 index declined 1.5% to 6,925.40 and the FTSE 100 index dropped 1% to 7,335.40. 

The yield on 10-year German Bunds decreased to 2.09%, French bonds edged lower to 2.67%, the UK gilts to 3.24% and Italian bonds to 4.04%. 

The euro edged higher to $1.067, the British pound inched up to $1.21 and the Swiss franc closed at 92.75 cents. 

Brent crude oil declined $2.37 yo $72.30 a barrel and the Dutch TTF natural gas futures fell 2.3% to Є43.10 per MWh.   

 

Europe Movers 

Diploma PLC increased 3.5% to 2,727.12 pence after the company said it completed the sale of 9.3 million shares for 2,525 pence a share and raised £235 million. 

The company said it plans to use proceeds to refinance the acquisition of Tennessee Industrial  Electronics, LLC, a value-add distributor of aftermarket parts and  repair services provider into the fast-growing US industrial automation end market, 

The company plans to use some of the proceeds to fund its "strong M&A pipeline to  accelerate future organic growth."

The purchase price of £76 million represents a multiple of 9.8 times operating earnings and the acquisition is expected  to deliver revenue of £31 million. 

Bodycote Plc increased 5.5% to 613.30 pence after the provider of thermal processing service and heat treatment reported revenue and earnings rose in in the full-year. 

Revenue in the full-year 2022 increased 17.3% to £743.6 million from £615.8 million and net income rose to £74.3 million from £60.0 million and earnings per share to 38.6 pence from 31.2 pence a year ago.