Banks receiving rescue deposits feels like ‘a Main Street vs. Wall Street dynamic’: Strategist

KBW Head of U.S. Bank Research Christopher McGratty joins Yahoo Finance Live to discuss the rescue plans taking place across the banking sector, including for First Republic Bank.

Video Transcript

SEANA SMITH: Let's talk a little bit more about First Republic Bank because it has certainly been the story here this week. Continuing the slide once again, now off just about 33% in intraday trading. Now that stock dragging the broader market with it.

Now this loss here comes despite the fact that the bank did secure a $30 billion lifeline from 11 of the largest US banks. Christopher McGratty, he's head of US bank research for KBW, a Stifel company, here to help us break down the action that we've seen over the last week or so. And, Chris, it's great to see you again.

You had a note out today talking about that rescue package. You characterized it as a temporary lifeline, not a permanent solution. So paint this picture for us and the difference that one week has really been for First Republic's balance sheet.

CHRISTOPHER MCGRATTY: Sure. Thanks for having me back. Yeah, it's been quite a week. You think about a week ago, you know, before Silicon Valley, before Signature Bank, the company was doing just fine. What's transpired over the weekend-- we talked about it earlier in the week-- this deposit run, if you will, from some of these large banks. And what we learned last night with the $30 billion that's coming from the 11 largest banks into First Republic is that the deposit outflows at First Republic have been significant. And so in turn, what the company has had to do is they've had to tap their borrowing capacity to build up liquidity.

INES FERRÉ: So, Chris, what does this do for regional banks as a whole? And is there now sort of a two-tier system when it comes to banking, the banks that are too big to fail, the banks that are backed, the banks that are seeing inflows, and then the regional banks that perhaps are more susceptible?

CHRISTOPHER MCGRATTY: Sure. I mean, this feels a bit like a main street versus Wall Street dynamic that's playing out, right? You've seen Silicon Valley, which caters to the venture-capital community; Signature Bank, which had a big crypto deposit base; and First Republic. This is a very clean company in terms of the balance sheet, but they have a very high-net-worth customer base. So these are very large deposits, and the concern over the weekend last weekend was the FDIC going to honor the uninsured piece of the deposits? Thankfully we saw that they did in both Signature and SVB. But for First Republic, you know, the issue here is this balance sheet has really transformed over the last four to five days, and many people are talking about the sustainability of this injection.

SEANA SMITH: Yeah, so, Chris, let's talk a little bit more about the sustainability of it. How dire is that outlook?

CHRISTOPHER MCGRATTY: Right. Let me just put it into context. So what we learned last night was over the last week, borrowings on First Republic's balance sheet have ranged from $20 billion to $109. So a huge increase from their borrowing at the Fed. Now, to put that into context, at the end of the year last year, they had $176 billion of deposits, so a huge range.

And what we didn't hear last night, which was, I think, leading to some of the weakness in the stock, is where those borrowing balances are today and where those deposit balances are today. So as analysts, we presume that the borrowing levels are at the higher end and the deposit levels are at the lower end.

INES FERRÉ: And, Chris, are there any banks that you like in this space, in the banking sector? I mean, going forward, what is all this going to mean for bank stocks?

CHRISTOPHER MCGRATTY: Sure. We're seeing-- we're seeing into the weekend investors take down exposures. They're concerned that we've seen failures last weekend, and this is what happened during 2008. Investors didn't want to take too much risk exposure into the weekend. And so we're seeing a sell-off in equities today, and we're seeing a sell-off in the bank stocks.

Now as we talked about earlier in the week, there are some opportunities with this disruption. We've talked about companies like Western Alliance. I see on your screen. This is a company that we actually did a meeting with yesterday. We wrote a note about this morning. They're doing just fine. They had outflows at the beginning of the week. Those have since stabilized. So there's a little bit of the baby and the bathwater dynamic going on within the banks.

But down the risk spectrum, there are pure commercial banks that are not high growth that are very high quality. Some of the names that we really like are East West Bank in California, Wintrust Financial out of Chicago, Old National in Indiana, and Webster Bank in Connecticut. These are traditional commercial banks that grow at a decent rate and aren't caught up in a lot of this volatility.

SEANA SMITH: Yeah, Chris, there's still a lot of risk out there, still a lot of uncertainty. I was talking to the CEO of one of these startups that has had to move their money since last week. There's still a lot of uncertainty just about whether or not-- or fear, I should say, that another bank could go under. Do you think we could see another bank failure?

CHRISTOPHER MCGRATTY: You know, I think that's what the FDIC is trying to prevent, right? If you look at what happened to the First Republic situation, you know, last week they got an additional line from JPMorgan, and they told us at the time they have $70 billion of liquidity. What we learned yesterday was $30 billion from the 11 largest banks in the country were moved onto First Republic's balance sheet. So what they're trying to do is they're trying to stabilize the situation until we know a little bit more about the ramifications of SVB and Silicon Valley.

SEANA SMITH: Chris, if we get another hike from the Fed next week, another 25 basis points, what's the impact on regionals there?

CHRISTOPHER MCGRATTY: Right. At this point of the cycle, the banks don't want rates to go up any further. So early in the cycle, the banks were what we call asset sensitive, meaning their margins expand as interest rates rise. But given the frequency and how quickly and significantly rates rose last year, at some point the deposit equation, the repricing of their liabilities exceeds that of their assets.

So at this point, the banks really don't want additional rate hikes to flow through. Now, it seems like we may get 25 next week, but I think the signaling will be very important, and I think market expectations-- look at the bond market the last few days. Yields have come way down. I think the market is taking out the probability of additional hikes, and that's because of the stress we've seen with the last week or so.

INES FERRÉ: Christopher McGratty, KBW head of US bank research, thanks so much for joining us.