Jamie Dimon, CEO of JPMorgan Chase & Co, testifies at a Senate Banking, Housing, and Urban Affairs Committee hearing on Capitol Hill on September 22, 2022 in Washington, DC.
Drew Anger | Getty Images
The whirlwind weekend in late April, in which the country’s largest bank took over the most troubled regional lender, marked the end of one wave of trouble — and the start of another.
After emerging with the winning bid for First Republic, the $229 billion lender to wealthy coastal families, JPMorgan Chase CEO Jamie Dimon delivered the reassuring words investors craved after weeks of stomach-churning volatility: “This part of the crisis is over.”
But even if the dust settles on a series government seizures of failed medium-sized banks, the forces that caused the regional banking crisis in March are still raging.
Rising interest rates will increase losses on securities held by banks and motivate depositors to withdraw money from accounts, straining the main way these companies make money. Losses on commercial real estate and other loans have just started to register for banks, driving their earnings down even further. Regulators will set their sights on medium-sized institutions after the collapse of Silicon Valley Bank exposed oversight weaknesses.
What’s coming is probably the most significant shift in the US banking landscape since the 2008 financial crisis. Much of the country 4,672 In the coming years, lenders will be forced into the arms of stronger banks, whether by market forces or regulators, according to a dozen executives, advisers and investment bankers who spoke to CNBC.
“You get a huge wave of M&A among smaller banks because they have to get bigger,” said the co-president of a top six US bank who declined to disclose and spoke candidly about consolidation in the industry. “We are the only country in the world with so many banks.”
How did we get here?
To understand the roots of the regional banking crisis, it helps to look back to the turmoil of 2008, caused by irresponsible lending fueling a housing bubble whose collapse nearly toppled the global economy.
The aftermath of that earlier crisis brought the world’s largest banks under scrutiny, requiring bailouts to avoid disaster. As a result, it was ultimately institutions with $250 billion or more in assets that underwent the most changes, including annual stress tests and tighter rules governing how much loss-absorbing capital to keep on their balance sheets.
Meanwhile, non-giant banks were considered safer and circumvented with less federal oversight. In the years after 2008, regional and small banks often traded at a premium to their larger peers, and banks that showed steady growth by targeting wealthy homeowners or early-stage investors, such as First Republic and SVB, were rewarded with rising share prices. But while they were less complex than the giant banks, they weren’t necessarily less risky.
The sudden collapse of SVB in March showed how quickly a bank could unravel, dispelling one of the industry’s key assumptions: the so-called “stickiness” of deposits. Low interest rates and bond-buying programs that defined the years after 2008 flooded banks with a cheap source of funding and led depositors to leave cash parked in accounts paying negligible rates.
“For at least 15 years, banks have been flooded with deposits and with low rates, it costs them nothing,” he said. Brian Grahama banking veteran and co-founder of consulting firm Klaros Group. “That has clearly changed.”
‘under stress’
After 10 consecutive rate hikes and making banks cup news again this year, savers have moved funds in search of higher yields or more perceived security. Now it is the banks that are too big to fail, with their implicit government backstop, that are seen as the safest places to park money. Major bank stocks outperformed regional stocks. Shares of JPMorgan are up 7.6% this year, while the KBW Regional Banking Index is down more than 20%.
That illustrates one of the lessons of the uproar in March. Online tools have made moving money easier and social media platforms have led to concerted fears about lenders. Deposits that were considered ‘sticky’ in the past, or that were unlikely to move, have suddenly become so slippery. Financing the sector is therefore more expensive, especially for smaller banks with a higher percentage of uninsured deposits. But even the mega banks are forced to pay higher rates maintain deposits.
Some of that pressure will become apparent when regional banks report second-quarter results this month. Banks incl Zions And Key Corp told investors last month said interest income came in lower than expected, and Deutsche Bank analyst Matt O’Connor warned regional banks could cut dividend payments.
JPMorgan kicks off bank earnings on Friday.
“The fundamental problem with the regional banking system is that the underlying business model is under pressure,” said Peter Orszag, CEO of Lazard. “Some of these banks will survive by being the buyer rather than the target. We could see fewer, larger regional banks over time.”
Walking injured
The industry’s dilemma is compounded by the expectation that regulators will tighten up supervision of banks, particularly those in the $100 billion to $250 billion asset range, in which First Republic and SVB participated.
“There will be a lot more costs coming down the pipeline that will put pressure on returns and profits,” he said. Chris Wolfea Fitch banking analyst who previously worked at the Federal Reserve Bank of New York.
“Higher fixed costs require more scale, whether you’re in steelmaking or banking,” he said. “Incentives for banks to get bigger just increased significantly.”
Half of the country’s banks are likely to be gobbled up by competitors in the next decade, Wolfe said.
While SVB and First Republic saw the largest deposit exodus in March, other banks were hurt in that chaotic period, according to a top investment banker who advises financial institutions. Most banks saw deposits fall below 10% in the first quarter, but those that lost more could be in trouble, the banker said.
“If you happen to be one of the banks that lost 10% to 20% of deposits, you’re in trouble,” said the banker, who declined to be identified, speaking of potential clients. “You either have to raise capital and deflate your balance sheet, or you have to sell yourself” to relieve the pressure.
A third option is to simply wait for the underwater bonds to finally mature and roll off banks’ balance sheets – or for falling interest rates to soften losses.
But that could take years, and it exposes banks to the risk of something else going wrong, such as increasing defaults on office loans. That could put some banks in a precarious position because they don’t have enough capital.
‘False Calm’
In the meantime, banks are already trying to unburden assets and businesses to boost capital, according to another veteran financial banker and former Goldman Sachs partner. They are weighing payments sales, asset management and fintech operations, this banker said.
“A fair number of them look at their balance sheets and try to figure out, ‘What do I have that I can sell and get a good price for’?” said the banker.
Banks are in trouble, however, as the market is not open to new sales of lenders’ shares despite their low valuations, according to Lazard’s Orszag. Institutional investors are staying away as further rate hikes could take the industry one step further, he said.
Orszag called the past few weeks a “false calm” that could be disrupted when banks publish second-quarter results. The industry still runs the risk that the negative feedback loop of falling stock prices and deposit runs could return, he said.
“All you need is one or two banks saying, ‘Deposits are down another 20%,’ and all of a sudden there are similar scenarios again,” Orszag said. “Pounding on stock prices, which are then fueled by deposit flight, which is then fed back into stock prices.”
Offers ahead
It may take a year or more for the mergers to get going, several bankers said. That’s because acquirers would absorb blows to their own capital when acquiring competitors with underwater bonds. Executives are also looking for regulators’ “all clear” signal on consolidation after several deals close sunk during the past years.
While Treasury Secretary Janet Yellen has issued a signal openness As for bank mergers, recent comments from the Justice Department point to a bigger deal strict supervision on antitrust issues, and influential lawmakers, including Senator Elizabeth Warren, oppose it more consolidation of banks.
When the deadlock breaks, deals are likely to be clustered into several tranches as banks try to optimize their size in the new regime.
Banks that once benefited from less than $250 billion in assets may find those benefits are gone, leading to more deals between medium-sized lenders. Other deals will create sizable entities below the $100 billion and $10 billion asset levels, which Klaros co-founder Graham says are likely regulatory thresholds.
Larger banks have more resources to keep up with upcoming regulations and consumer technology demands, advantages that have helped financial giants including JPMorgan grow their revenues steadily despite higher capital requirements. Still, the process probably won’t be comfortable for sellers.
But need for one bank means opportunity for another. merged banka New York-based institution with $7.8 billion in assets that focuses on unions and nonprofits will consider acquisitions after stock price recovers, according to CFO Jason Darby.
“Once our currency gets back to where we think it’s more appropriate, we’ll look at our ability to roll up,” Darby said. “I think you’ll see more and more banks raising their hands and saying, ‘We’re looking for strategic partners’ as the future unfolds.”