Western Alliance (WAL) lost $6 billion in deposits amid the chaos that roiled the banking world in the first quarter. Profits at the Phoenix-based lender dropped 41% from a year earlier.

And yet its stock rose 24% the day after announcing those results.

Investors have been looking for any signs that the crisis that saw three US banks fail in a matter of days back in early March is over. They're particularly keen for signals from the regional banks most vulnerable to the panic that cascaded through the financial system in the weeks that followed.

Reports over the past week from more than 15 regional lenders offered plenty of those signs, as multiple executives said the deposit outflows they saw in March had since stabilized or even reversed.

Horizon Investments head of portfolio strategy Zach Hill called the earnings results this past week "better than feared."

The banking crisis "does feel like it's largely contained," added Quant Insight head of analytics Huw Roberts.

Wedbush analyst David Chiaverini told Yahoo Finance the theme dominating this earnings season so far is "less than feared."

At Western Alliance, deposits rose by $2 billion in the first two weeks of April.

"The waters are now calmer," Western Alliance CEO Ken Vecchione told analysts this week.

This doesn’t mean, however, that all is fine for the many mid-sized banks that lack the power or diversity of industry giants such as JPMorgan Chase (JPM) and Bank of America (BAC).

Many of these smaller institutions said they now expect to earn less on their loans and pay more for their deposits, thus lowering expectations of revenue and profits in the future. Some also said they expect stricter federal banking regulations that could force them to raise more capital.

On Friday Moody's reinforced this challenging outlook by downgrading ratings for 11 regional lenders, including a two-notch cut for Western Alliance, citing "a deterioration in the operating environment and funding conditions for US banks."

"Some of the immediate problems have gone away but the reality is with interest rates higher the banks’ business model is going to have to change, and that’s going to play out over months and quarters and even years," Commonwealth Financial Network CIO Brad McMillan told Yahoo Finance.

Higher costs, lower profits

Their problems start with a critical source of funding for smaller institutions: deposits. Even before the failure of Silicon Valley Bank, bank customers who were earning little interest from their accounts had begun moving their money to higher-yielding alternatives such as certificates of deposit or money market funds.

That outflow accelerated in March. Comerica (CMA), a regional bank in Dallas, said its deposits fell 9% during the first three months of the year. Zions (ZION), a Salt Lake City lender, said they dropped 3.4%.

That forced many regional lenders to start paying more to keep depositors or attract them back. Deposit costs for Comerica rose 2,850% from a year ago, to $118 million. At Zions, these costs were up 1,266%, to $82 million. At Cincinnati lender Fifth Third (FITB) and Cleveland lender KeyCorp (KEY), the increases were 4,245% and 2,400%, respectively. Comerica and Zions were among the banks that received downgrades from Moody's on Friday.

Those higher costs, in turn, are beginning to cut into a key measure of profitability known as net interest income, which is the difference between what a bank earns on its loans and pays out on its deposits. Many regional banks said their net interest income dropped from the fourth quarter of 2022 and they expect it to drop again in the second quarter of this year as the Federal Reserve keeps interest rates high.

KeyCorp and Fifth Third were among the banks that reduced their net interest income expectations. Comerica said it expects that number to drop 11-13% in the three months ending June 30.

But Comerica executives also said they expect some of the deposits they lost to come back. Much of the outflows in March, they said, happened because long standing customers decided to move some excess amounts elsewhere. Because those relationships are strong, customers may return.

"I don’t think we are going to have to pay up for it," senior executive vice president Peter Sefzik told analysts Thursday.

'No crisis inside our four walls'

Several executives from regional banks said some concerns about their corner of the industry were overhyped. After all, recent data shows that deposit outflows among banks below $250 billion in assets have slowed since March. These institutions even regained $20 billion in the two weeks ending April 12, according to Fed data released Friday.

Fifth Third CEO Tim Spence told analysts Thursday his institution is particularly well situated to benefit from a recent surge in manufacturing jobs across his regions in the Midwest.

"Markets have been trading on narratives over fundamentals," he said, adding that "there was no crisis inside our four walls."

Western Alliance's CEO, Vecchione, admitted that depositors withdrew $8 billion from his bank in one day during March but said deposits began returning within a week. After gaining back $2 billion during the first two weeks of April it expects to pull in another $2 billion per quarter this year.

"We've returned to a lot more calm," Vecchione said.

Some of that new industry calm could get tested again next week as more regional banks report results. Plenty of investors will be paying close attention to one specific name that was at the center of last month’s crisis, First Republic (FRC), which is scheduled to release first-quarter earnings Monday. In March the San Francisco lender took a $30 billion deposit infusion from 11 rival banks in a bid to restore confidence. It was also among the banks that received downgrades from Moody's on Friday, specifically on its preferred-stock rating.

A lot of money is riding on its fate. Everyday investors have bet $245 million on First Republic stock since the fall of Silicon Valley Bank, according to Vanda Research, the third highest inflow to a specific bank stock behind Bank of America and Charles Schwab (SCHW). It also has one of the highest levels of interest among so-called short sellers betting on the stock to decline, according to analytics firm S3 Partners, accounting for $480 million in such bets over the last 30 days.

First Republic "will be a bellwether of sentiment for the sector" Vanda said in a note this past week.

Western Alliance’s CEO told analysts Wednesday that his bank had proved it was now in a different category than First Republic.

"There was a point where whatever happened to them affected us. But I think we've now separated ourselves."

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