The Pressures Facing Regional Banks in the US

The Pressures Facing Regional Banks in the US

The landscape for regional banks in the United States is posing significant challenges on their returns and profitability, leading many to consider potential acquisition by larger competitors. According to analysts at KBW, banks with assets ranging from $80 billion to $120 billion are particularly vulnerable in this tough environment. Christopher McGratty of KBW highlights that this group of banks has the lowest structural returns among institutions with at least $10 billion in assets. As a result, they are faced with the tough decision of either growing larger to accommodate forthcoming regulations or struggling for years to come. Of the eight banks falling into this asset range, McGratty suggests that Comerica, Zions, and First Horizon may eventually be acquired by more profitable rivals. However, both Zions and First Horizon have declined to comment on this speculation, while Comerica has yet to provide a response to the analysis. On the other hand, McGratty acknowledges that Western Alliance and Webster Financial, within the same cohort, have demonstrated above-average returns and may be able to remain independent but could also consider selling themselves. The remaining banks in this range, including East West Bank, Popular Bank, and New York Community Bank, have higher returns and could potentially become acquirers rather than targets. McGratty emphasizes the importance of scale and profitability, indicating that not all banks are equally profitable, and scale demands should be taken into account.

The proposal of comprehensive regulatory changes has further intensified the challenges facing regional banks. Following the collapse of three midsized banks due to higher interest rates and deposit runs, banking regulators have developed measures that apply to institutions with at least $100 billion in assets. This has led to increased compliance and funding costs for smaller regional players, placing further strain on their profitability. Although shares of regional banks have declined by 21% this year according to the KBW Regional Banking Index, recent weeks have seen a slight recovery as concerns over inflation have subsided. However, the sector remains burdened by apprehensions regarding the implications of new rules and the potential risk of a recession impacting loan losses, particularly within commercial real estate.

The KBW analysis predicts that banks will ultimately cluster into three groups in order to optimize profitability. These groups include those with assets above $120 billion, $50 billion to $80 billion, and $20 billion to $50 billion. Smaller banks with assets of less than $10 billion enjoy certain advantages tied to debit card revenue, but they are advised to grow to at least $20 billion in assets to offset this loss. The challenge arises for banks with assets ranging from $80 billion to $90 billion, such as Zions and Comerica. Market expectations assume that these banks will soon face the burdens associated with being $100 billion-asset banks, leading to a compression in their valuations. Conversely, larger banks like Huntington, Fifth Third, M&T, and Regions Financial, which already boast strong returns, are well-positioned to expand through the acquisition of smaller lenders. While other analysts hold a more optimistic view, KBW had already downgraded the US banking industry in late 2022, months prior to the regional banking crisis. It is worth noting that KBW is known for its expertise in determining the composition of indexes that track the banking sector.

Although banks are currently awaiting clarity on regulations and interest rates before actively pursuing deals, the theme of consolidation remains constant within the banking industry. McGratty points out that history has shown that banks often figure out the rules when certain asset thresholds are established. Furthermore, the pressures facing regional banks may ultimately drive them towards seeking acquisitions or forming partnerships with larger and more profitable counterparts in order to survive and flourish in the evolving financial landscape.

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