Traders work on the trading floor of the New York Stock Exchange (NYSE) on February 7, 2024 in New York City, the United States.
Brendan McDermid | Reuters
Three regional banks were depleted in March 2023, leaving hundreds of smaller lenders injured as M&A activity – a key potential lifeline – slowed to a trickle.
As memories of last year’s regional banking crisis begin to fade, it’s easy to believe the industry has turned the corner. But the high interest rates that drove Silicon Valley banks and their peers to collapse in 2023 are still at play.
As of July, the Federal Reserve has raised interest rates 11 times, but has not yet begun to lower benchmark interest rates.As a result, hundreds of billions of dollars unrealized loss Low-interest bonds and loans remain hidden on banks’ balance sheets. That, combined with potential losses in commercial real estate, leaves much of the industry vulnerable.
Consulting firm analyzed about 4,000 U.S. banks Claros GroupThe 282 institutions had both high levels of commercial real estate exposure and large unrealized losses from soaring interest rates — a potentially toxic combination that could force these lenders to raise new capital or merge.
The research is based on what is called call reportscreened for two factors: banks with commercial real estate loans accounting for more than 300% of capital, and companies with unrealized losses on bonds and loans resulting in capital levels below 4%.
Claros declined to name the institutions in the analysis for fear of triggering a run on deposits.
But this analysis only found one company with more than $100 billion in assets, and given the factors studied, it’s not hard to pinpoint: New York Community BankThe real estate lender averted disaster earlier this month with $1.1 billion in funding capital injection Private equity investors led by former Treasury Secretary Steven Mnuchin.
Most of the banks considered to face potential challenges are community lender Assets are less than US$10 billion. Only 16 companies are in the next size category that includes regional banks (between $10 billion and $100 billion in assets), even though they collectively hold more assets than the 265 community banks combined.
Behind the scenes, regulators have been urging banks to improve capital levels and staffing through secret orders, the Klaros co-founder said. Brian Graham.
“If just 10 banks were in trouble, they would all be shut down and dealt with,” Graham said. “When hundreds of banks are facing these challenges, regulators have to walk a tightrope.”
Graham said these banks will either need to raise capital, possibly from private equity sources like NYCB, or merge with stronger banks.That’s what PacWest did last year; the California lender is acquired It was acquired by a smaller rival after losing deposits during the March riots.
Graham said banks could also choose to wait for the bonds to mature and roll them off their balance sheets, but doing so would mean continued declines in revenue for competitors, essentially operating as “zombie banks” that don’t support the communities in which they operate. economic growth. The strategy also puts them at risk of being swamped by rising loan losses.
Powell’s warning
Fed Chairman Jerome Powell acknowledges commercial real estate losses this month possible Destroy some small and medium-sized banks.
“I’m sure this is a problem that we’re going to spend years solving,” Powell said. “Banks are going to fail.” Tell legislator. “We’re working with them … I think it’s manageable, that’s the word I would use.”
There are other signs of growing pressure on smaller banks. Fitch analysts said in a report that 67 lenders will have low levels of liquidity – cash or securities that can be sold quickly if needed – in 2023, up from nine institutions in 2021 . recent reports. Their assets range from $90 billion to less than $1 billion, according to Fitch.
Regulators have added more companies to theQuestion bank list“Companies with the worst financial or operating ratings last year. There are 52 lenders on the list with total assets of $66.3 billion, 13 more than a year ago, according to the Federal Deposit Insurance Corporation.
“The bad news is that the problems facing the banking system are not magically going away,” Graham said. “The good news is that compared to other banking crises I’ve been through, this is not a situation where hundreds of banks are insolvent.”
‘Pressure cooker’
Following the collapse of SVB last March, the then second-largest U.S. bank failed, followed by Signature Bank Days later and following the failure of First Republic in May, many industry insiders predicted a wave of consolidation that could help banks cope with higher funding and compliance costs.
But transactions were few and far between. Fewer than 100 bank acquisitions were announced last year. according to Consulting firm Mercer Capital. The report found that the total value of transactions was $4.6 billion, the lowest level since 1990.
One complication: Bank executives are unsure whether their deals will pass regulatory scrutiny.Approval times have been extended, especially for larger banks, and regulators have killed Recent deals such as the $13.4 billion acquisition of First Horizon Toronto TD Bank.
The planned merger of Capital One and Discovery, announced in February, was immediately met with calls from some lawmakers. clogged trade.
“Banks are in a pressure cooker,” said Chris Caulfield, senior partner at consulting firm West Monroe. “Regulators are playing an increasing role in M&A, but at the same time they are putting banks, especially the larger ones, at risk. It becomes more difficult for smaller banks to be profitable.”
Investment bankers at three of the world’s largest advisory firms said that despite a slow deal environment, leaders of banks of all sizes are aware of the need to consider mergers.
The banker, who requested anonymity to discuss clients, said the current level of discussions with bank chief executives was the highest in his 23-year career.
“Everyone is talking and acknowledging that there has to be consolidation,” the banker said. “There has been a structural change in the industry from a profitability perspective because of regulation and because deposits are now no longer zero cost. “
executive eldership
Another reason M&A activity is expected to increase is the age of bank leaders. A third of regional bank chief executives are over 65, exceeding the group’s average retirement age, according to 2023 data from executive search firm Spencer Stuart. The company said this could lead to a wave of departures in the coming years.
“There are a lot of people who are tired,” said Frank Sorrentino, an investment banker at boutique consulting firm Stephens. “It’s a tough industry and there are a lot of sellers willing to do a deal, whether it’s an outright sale or a merger.”
Sorrentino participates in January merge between the first sun and Home StreetA Seattle-based bank saw its stock price plummet last year as it struggled with cash. He predicts a surge in M&A activity among lenders as smaller companies seek to expand, with assets reaching $3 billion to $20 billion.
One factor holding back mergers is excessive price reductions in bonds and loans, which can erode the combined entity’s capital in a deal because certain portfolio losses must be realized in the deal. The situation has eased since late last year as bond yields have retreated from 16-year highs.
Sorrentino said a recovery in bank stocks will lead to more activity this year. Other bankers said larger deals were more likely to be announced after the U.S. presidential election, which could usher in a new set of leaders in key regulatory roles.
Mike Mayo, a veteran bank analyst and former Fed employee, said paving the way for a wave of U.S. bank mergers would strengthen the system and create challengers for the big banks.
“Bank mergers should be a game, especially when the strong take over the weak,” Mayo said. “Restrictions on mergers in the industry are the equivalent of the Jamie Dimon Protection Act.”
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