What is the end-game for Regional Banks and why it matters

What is the end-game for Regional Banks and why it matters

May 05, 2023

The failure of First Republic Bank on Monday, May 1st, was the third major bank failure in the U.S. in less than seven weeks. https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/

The autopsy of these institutions are, in my opinion, virtually a pointless exercise. It's a bit like determining why someone died from a car crash - blunt force to the head, bleeding, heart attack... The car crash was the cause.  For regional banks, the "car crash" has been the Fed's hiking cycle which continued earlier this week with another 25 basis point increase to short rates.

So where does this lead and why does it matter?

Well, first let's recognize that the "take under" of First Republic Bank by J.P. Morgan Chase adds to the list of bank consolidations that have been happening for decades. I believe there is a trend - less banks and a consolidation of assets at the larger "too-big-to-fail" institutions. 

That aside, what may be problematic to the economy is the contraction of credit that is likely to be happen as a result of the rate increase and failed banks. Pair this with the potential problems in commercial real estate and private equity and we could have serious ramifications that our economy and Fed could have to work through in the coming quarters.

Now, where does this lead and what should you as an investor or person planning your retirement do?

As to where this leads, I believe a few things are likely; (1) Lower interest rates - The yield curve continues to be inverted with short rates at 5.25% and the ten-year treasury yielding 3.45% at this writing. At some point, because of our national debt and the fact that some inflationary numbers may still be factoring in stimulus payments, we may trend back to recession indicators and the Fed may have to start cutting rates. I just do not see a world where the U.S. runs budget deficits with $31.4 Trillion in debt whilst raising rates to 6% and beyond. Could I be wrong? Of course. However, I still believe rates may decrease. (2) Policy & Regulation changes - perhaps an increase from $250K to $500K+ on FDIC insurance as well as a few dozen added banking regulations? (3) A bigger balance sheet at the Federal Reserve.

So what should investors do?

First and foremost, you should have a portfolio that is tailored to your goals, risk tolerance, financial situation, and the capital market environment. If you don't have this, stop reading this blog and start the process (Rich Wealth Management is happy to help).  To the extent you have already done this, I don't think abrupt changes are needed at this time.  The market is going to play out over time and the regional banking issues will all get digested into the economy. Commerce continues. Companies will continue to make profits. The end of the world only happens once and I don't think it's a 2023/2024 event. Fingers crossed!

If you are an investor with a shorter time horizon and/or are approaching retirement, I think adjusting your portfolio to more conservative investments and asset allocation, given all that is happening, could make sense.  We like to see our clients build a cash "war chest" as they approach retirement and we have a process of determining how much is appropriate for each client.

Please feel free to contact me if you have any questions.

Best,


Dwight

*The attached chart is of the SPDR S&P Regional Banking ETF. This does not represent a solicitation of this or any other security. It is for informational purposes only. Source: Thomson One.


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