JPMorgan Chase & Co CEO Jamie Dimon recently testified during a Senate Banking, Housing, and Urban Affairs Committee hearing in Washington, DC. In late April, JPMorgan Chase acquired troubled regional lender First Republic, signaling the end of one set of problems but the beginning of another. Despite the government seizures of failed midsized banks, the factors that led to the regional banking crisis in March are still present.
The rising interest rates will lead to deeper losses on bank-held securities and prompt savers to withdraw cash from their accounts, causing a squeeze on the main source of revenue for banks. Additionally, losses on loans, especially commercial real estate loans, will further diminish profits for banks. Regulators will now shift their focus to midsized institutions following the collapse of Silicon Valley Bank, which exposed supervisory lapses.
This upcoming wave of mergers and acquisitions among smaller banks is expected to be the most significant change in the American banking landscape since the 2008 financial crisis. According to industry insiders, many of the 4,672 banks in the country will be forced to merge with stronger banks in the coming years due to market forces or regulatory pressure. The increased consolidation is driven by the need for smaller banks to become bigger.
To understand the roots of the regional bank crisis, it’s important to look at the turmoil of 2008, which was caused by irresponsible lending and the resulting collapse of the housing bubble. Following the crisis, the largest banks faced increased regulations, stress tests, and stricter capital requirements. Meanwhile, smaller banks appeared safer and had less government oversight. Regional and small banks, which catered to wealthy homeowners and startup investors, enjoyed rising stock prices. However, the sudden collapse of Silicon Valley Bank in March shattered the assumption that deposits were stable. The historically low interest rates and bond-purchasing programs flooded banks with cheap funding, but now depositors are seeking higher yields and perceived safety, resulting in the too-big-to-fail banks being seen as the safest place to keep money.
Moving money has become easier with online tools, and fears regarding lenders can spread quickly through social media platforms. Deposits that were previously considered stable are now prone to movement. This shift in depositor behavior has led to increased funding costs for the industry, particularly for smaller banks with a higher percentage of uninsured deposits. Even the largest banks have had to offer higher rates to retain deposits.
The current pressures and challenges will be evident in the second-quarter results of regional banks. Some banks have already reported lower-than-expected interest revenue, leading to potential dividend cuts. The regional banking model is under stress, and banks may need to increase their scale to offset rising costs and remain competitive. Industry experts predict that over the next decade, half of the country’s banks will be acquired by competitors.
Aside from market pressures, regulators are expected to tighten oversight of banks, particularly those in the $100 billion to $250 billion asset range. The collapse of banks like First Republic and Silicon Valley Bank in this asset range has drawn attention to supervisory lapses. These regulatory changes are projected to lead to higher costs for banks and further exacerbate their earnings pressure.
In light of these challenges, banks are considering asset sales to boost their capital. However, selling off assets is difficult because the market is not receptive to fresh sales of bank stocks. Institutional investors are hesitant due to the potential impact of further interest rate increases on the sector. While there may be a temporary calm, the negative feedback loop of falling stock prices and deposit runs could return and have a detrimental impact on the industry.
Mergers and acquisitions among banks are expected to increase in the coming years, but it may take some time for them to ramp up. Acquiring banks will need to absorb the capital hits from taking over banks with underwater bonds. Additionally, executives are waiting for regulatory signals on consolidation after several recent deals were scrutinized for antitrust concerns. While Treasury Secretary Janet Yellen has shown openness to bank mergers, the Justice Department indicates greater scrutiny on antitrust issues.
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