SignalPlus Morning Briefing?—?Rates Go Up, Banks Go Down

Despite strong S&P earnings (80%+ positive surprise rate out of 137 firms reported), strong durable goods data, and better deposit growth data out of PacWest, First Republic Bank (FRC) continued to grab all the attention with the stock trading down another 30% today and threatening to breach $1bln in market cap.?As a quick refresher on the current situation:

• As a contrast to SVB, which was tech-focused, FRC is a real estate sector focused financial institution
• FRC has taken ~$200bln in deposits over the past few years, and had lent most of them (~$180bln) out in low yielding (3%) mortgage and other RE related loans
• Unfortunately, with overnight rates now at 5%, their lending book is now highly unprofitable (negative carry)
• Any fire-sale of the loan-book will likely carry a -50% (or more mark) from the mark-to-market on interest rates alone, not to mention liquidity discount
• A 50% drawdown is another $100bln hole in the bank’s balance sheet
• Depositors have been pulling out their cash steadily throughout the past 2 months
• A consortium of 11 large banks had collectively parked $30bln of their own deposits to FRC to stave off bankruptcy pressures back in March

Some reasons for the renewed FUD:

• FRC Q1 earnings report showed a sharper drop of deposits to just $104bln vs expectations of $137bln, with just $45bln of cash on hand and unused borrowing capacity
• The bank announced that it is weighing up to $100bln in asset sales to clear the path for a capital rise
• FRC has been unsuccessful with finding a buyer for both their equity as well as their loan book, and fire-sales would incur such large capital losses that it would impair their balance sheet anyway
• Furthermore, bidders have also been conditioned to believe that they can get a better deal at the moment of bankruptcy, as evident from where SVB/Signature Bank/Credit Suisse were effectively ‘sold’
• As of yesterday, policy officials appear to be unwilling to step in to help FRC at this point as they feel that the bank has been given plenty of time over the past 2 months to find a recapitalization solution
• Furthermore, the FDIC is apparently weighing the prospect of downgrading their private assessments of FRC (‘CAMEL’ rating), which might eventually curb the beleaguered bank’s access to the Fed’s emergency lending facilities (Source: Bloomberg)
• The ‘only way out’ is if the Fed were to cut rates back to 2% (-300bp) in a hurry to revive the mark-to-market losses on FRC’s loan book… Not going to happen, unfortunately

Once again, unlike previous episodes of QE in the early 2010s,?regulators and policymakers are much less lenient with blanket coverage and bailouts of troubled institutions, especially as the problems are stemming from interest rate mis-management,?with losses likely to be socialized to equity holders and large banks instead of general depositors and public savers.

Outside of FRC troubles, economic data was mixed on the day, with positives seen in durable goods orders which increased by 3.2% MoM in March, far surpassing expectations of 0.8% MoM, though gains were skewed by significant gains in aircraft and parts. US mortgage applications also rose 3.7% on the week, reversing last week’s losses, and the US trade balance deficit was also narrower than expected. However,?Atlanta Fed’s GDPnow was revised significantly lower to 1.1% from last week’s 2.5% estimate, citing weaker drags from personal consumption expenditures and domestic investment growth.

On the other hand,?S&P 500 earnings have largely been coming in above the (admittedly) low expectations, with Meta the last to beat with an upbeat revenue forecast thanks to some recovery signs in digital advertising. The tech giant also announced that it has purchased over $9 billion of shares in Q1, with room for another $42 billion of purchases for the upcoming quarters. The stock is rallying 9% in after-hours, and continues the string of tech bellewether beats following Alphabet and Microsoft. The tech sector was the only name to show gains yesterday in an otherwise sea of red for the SPX over renewed banking concerns.

However, while not necessarily a bearish impulse on its own, the S&P 500 has dramatically out-performed its smaller-cap weighted brethren in the Russell 2000,?signalling that the recovery in equity sentiment continues to be concentrated in a handful of market giants rather than the broader index.

On the political side, the Republican-controlled house passed their debt limit legislation yesterday, seeking an increase in the debt ceiling by $1.5T over the next 12 months. However, this has zero chance of passing the Democrat Senate, but signals the beginning of a likely long road of congressional brinksmanship on the debt limit situation. On the positive side,?US treasury tax receipts on April 25th came in stronger than expected, falling only by -14% YoY instead of the projected pace of -28% YoY and -35% YoY recorded earlier in the month. This likely pinpoints the eventual debt ceiling breach to be around July, instead of late May / early June as a worst case scenario.

In crypto, while the latest FRC concerns helped to spur a strong rally in BTC to touch $30K in the NY session, heavy end of day selling drove prices -9% lower in a straight line, leading to significant and likely painful future liquidations on both the long and short sides.?Bitcoin price action has been increasingly correlated with movements in gold instead of equities ever since March, with yesterday’s sudden sell-off corresponding almost perfectly with the stop-loss run in gold as it failed to hold $2k.

Option activity was more balanced with two-way interest on $30k BTC calls, while option vol and skews are finally showing signs of life to the upside on further signs of banking trouble.?Near-term crypto price action will likely be dictated by where gold prices go from here?and markets observe any further fallout from FRC, and of course the all-important FOMC meeting next Wednesday.

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