At Milken, investors praise bank rescue but brace for more drama

By Svea Herbst-Bayliss and Carolina Mandl

BEVERLY HILLS (Reuters) -Investors breathed easier on Monday after a weekend auction found a buyer for troubled First Republic Bank (NYSE:), though some said they were worried the crisis in regional banks is not over and hedge funds bet other dominos may still fall.

As Wall Street money managers, banking executives and pension fund managers gathered at the Milken Institute Global Conference, the main topic over cocktails on Sunday night and in conference rooms the following morning was JPMorgan Chase & Co (NYSE:)’s purchase of First Republic Bank.

“There is a little bit of a tendency to breathe a sigh of relief on mornings like this and I think we got through that,” David Hunt, chief executive of global asset manager PGIM said at the conference.

Actually, the drama may be “just starting,” he said.

Policymakers, executives and investors at the conference said constrained lending as a result of banking sector regulation could choke off credit to the economy.

For hedge funds, many of whom have spent weeks betting regional bank stocks would fall further, the scenario has created a chance to add new short positions or keep existing ones, several executives at large funds said.

Shares of several regional lenders fell on Monday, a sign that investor nerves were still on edge after First Republic’s collapse, the third major casualty of the biggest crisis to hit the U.S. banking sector since 2008.

Senior banking executives said they were gauging how aggressive short-sellers might be in coming weeks and which of the regional banks might be burdened with significant loans for office real estate at a time many buildings are standing empty as employees continue to work from home.

“The real estate we’re more worried about is more of the bottom end of the stack of CMBS (commercial mortgage-backed securities),” Citigroup (NYSE:) Chief Executive Jane Fraser told a panel. “It will be a stress point for sure.”

Bearish fund managers declined to detail their exact bets for fears that retail investors might band together and squeeze the stock prices higher, hurting those who had bet against their shares. That tactic that helped fuel massive rallies in shares of GameStop (NYSE:) and other so-called meme stocks in early 2021.

Nevertheless, betting against bank stocks has been a profitable endeavor this year, which has seen the high-profile failures of Silicon Valley Bank and Signature Bank (OTC:), in addition to First Republic and a state-engineered rescue of Credit Suisse by the Swiss government.

The KBW Regional Banking Index, which fell 2.7% on Monday, is down almost 23.6% year-to-date, while First Republic’s shares are off 97% since January.

As fund managers sipped cocktails on Sunday night before the conference, another popular topic was the Federal Reserve, which is widely expected to raise rates by another 25 basis points at the end of its May 3 meeting and signal a pause in the aggressive rate hiking cycle that has shaken markets for the past year.

While futures markets show investors’ pricing in rate cuts after the summer, such a trajectory for rates could also mean the central bank is reacting to a rapid growth slowdown, some conference participants said.

“It is hard to imagine the Fed lowering rates to the degree that it’s priced in without a much more serious economic downturn,” said Karen Karniol-Tambour, Co-Chief Investment Officer at hedge fund Bridgewater Associates.