Here's what's next for bank stocks after the failure of First Republic

Published Mon, May 1 202310:31 AM EDTUpdated Mon, May 1 20236:06 PM EDT

Jesse Pound @/in/jesse-pound @jesserpound

The seizure and sale of First Republic Bank over the weekend closed the book on the most glaring problem left from the U.S. regional banking crisis, but now investors will turn to see if new stresses emerge and evaluate whether midsize banks can become good bets in the future. First Republic's demise was the third regional bank failure since early March, when Silicon Valley Bank and Signature Bank folded within days of each other. There is cautious optimism on Wall Street that First Republic will be the last failure of this period. "We believe the FRC sale should likely end forced sales of banks due to deposit flight. Although there will likely be other banks that may experience profitability challenges, causing mgmt teams to evaluate strategic options," Bank of America analyst Ebrahim Poonawala said in a note to clients. First Republic's final slide came after its first-quarter earnings report on April 24, which showed a 40% drop in deposits over the first three months of the year. However, reports from other regional banks weren't nearly as dire, with many reporting that deposits had stabilized and were growing again. For example, PacWest Bancorp . — which was seen as a potential area of stress after SVB's collapse, and whose shares fell more than 10% Monday — said last week that it had brought in about $1.8 billion of deposits since March 20. PACW 1D mountain PacWest's stock was under pressure on Monday. "There are only so many banks that were offsides this way. There may be another smaller one, but this pretty much resolves them all. This part of the crisis is over ," JPMorgan Chase CEO Jamie Dimon said on a conference call Monday to discuss the purchase of First Republic. However, the failure of First Republic could cause some more turbulence, at least in the short term, for both deposits and bank stocks. "While the bank balance sheet data were generally positive for the week ending April 19, we could see disruptions in upcoming weeks because of recent market concerns around a specific bank," Bank of America senior U.S. economist Aditya Bhave said in a note to clients on Monday. Even assuming that banks can hold on to their customers, doing so will be expensive. Deposits are shifting into CDs and other high rate products, Morgan Stanley's Betsy Graseck said in a note to clients, which will hurt the profit margins for banks. "That ongoing mix shift and pricing pressure is reflected in the latest acceleration in banks' highest CD offers. It also corroborates our view that the events of the past month are placing an incremental premium on bank deposits which is likely to continue pushing betas higher over the course of 2023, even after the Fed pauses rate hikes," Graseck wrote on Monday. Long-term challenges The effect of SVB and other recent failures on the broader banking system is far from fully realized. The Federal Reserve report on the bank's collapse hinted at regulatory changes that could make life tougher for midsize regionals for years to come. "We believe that banks with assets > $500B and < $60B are the clearest winners in the new world order, while there is likely to be a no-man's land between $80-120B, as banks in this range may need to shrink to avoid new regulations or more actively engage in M & A to increase scale and absorb regulatory costs," KBW analyst David Konrad said in a note to clients on Sunday. The regulatory shifts could create a wave of asset sales and small deals as banks try to adjust to a new rule book. "Expect regional banks to likely respond by reducing capital returns, optimize lending and potentially dispose of assets to strengthen capital," Goldman Sachs analyst Ryan Nash said in a note to clients on Sunday. To be sure, the rapid deposit flight in March showed that the financial picture for banks can change quickly in the digital age. Commercial real estate concerns could be one area that causes bank stress, with Charlie Munger among the many investors warning the public about that sector. Investors may want to sit on the sidelines until the coast is more clear. "We don't believe that regional banks are completely out of the woods," Wolfe Research chief investment strategist Chris Senyek said in a note to clients on Monday. — CNBC's Michael Bloom contributed to this report.