The Regional Banking Crisis of 2023: What’s Next for Smaller Banks
As the memory of last year’s regional banking crisis begins to fade, it’s easy to believe the industry is in the clear. But the high interest rates that caused the collapse of Silicon Valley Bank and its peers in 2023 are still at play.
After hiking rates 11 times through July, the Federal Reserve has yet to start cutting its benchmark. As a result, hundreds of billions of dollars of unrealized losses on low-interest bonds and loans remain buried on banks’ balance sheets. That, combined with potential losses on commercial real estate, leaves swaths of the industry vulnerable.
Of about 4,000 U.S. banks analyzed by consulting firm Klaros Group, 282 institutions have both high levels of commercial real estate exposure and large unrealized losses from the rate surge — a potentially toxic combo that may force these lenders to raise fresh capital or engage in mergers.
The study, based on regulatory filings known as call reports, screened for two factors: Banks where commercial real estate loans made up over 300% of capital, and firms where unrealized losses on bonds and loans pushed capital levels below 4%.
Klaros declined to name the institutions in its analysis out of fear of inciting deposit runs.
But there’s only one company with more than $100 billion in assets found in this analysis, and, given the factors of the study, it’s not hard to determine: New York Community Bank, the real estate lender that avoided disaster earlier this month with a $1.1 billion capital injection from private equity investors led by ex-Treasury Secretary Steven Mnuchin.
Most of the banks deemed to be potentially challenged are community lenders with less than $10 billion in assets. Just 16 companies are in the next size bracket that includes regional banks — between $10 billion and $100 billion in assets — though they collectively hold more assets than the 265 community banks combined.
Behind the scenes, regulators have been prodding banks with confidential orders to improve capital levels and staffing, according to Klaros co-founder Brian Graham.
“These banks need to either raise capital, likely from private equity sources as NYCB did, or merge with stronger banks,” Graham said. “That’s what PacWest resorted to last year; the California lender was acquired by a smaller rival after it lost deposits in the March tumult.”
Federal Reserve Chair Jerome Powell acknowledged this month that commercial real estate losses are likely to capsize some small and medium-sized banks.
“There are other signs of mounting stress among smaller banks. In 2023, 67 lenders had low levels of liquidity — meaning the cash or securities that can be quickly sold when needed — up from nine institutions in 2021, according to Fitch analysts said in a recent report.
Despite the slow environment for deals, leaders of banks all along the size spectrum recognize the need to consider mergers, according to an investment banker at a top-three global advisory firm. Discussion levels with bank CEOs are now the highest in his 23-year career.
Another reason to expect heightened merger activity is the age of bank leaders. A third of regional bank CEOs are older than 65, beyond the group’s average retirement age, according to 2023 data from executive search firm Spencer Stuart.
Easing the path for a wave of U.S. bank mergers would strengthen the system and create challengers to the megabanks, according to Mike Mayo, the veteran bank analyst and former Fed employee.
In conclusion, the aftermath of the regional banking crisis of 2023 has left hundreds of smaller banks wounded and vulnerable. The industry is facing challenges with high interest rates, potential losses on commercial real estate, and mounting stress among banks of all sizes. The need for mergers, capital raising, and improved regulatory oversight is crucial to help these banks navigate these challenging times and emerge stronger in the future.
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