Why Many Regional Banks Could Be in Major Trouble
Somewhere in between national banks and community banks sit regional banks. These institutions cover more ground (literally) than community banks, but are considerably smaller players than national banks. According to FDIC call reports, U.S. regional banks have assets between $10 billion and $100 billion.
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Regional banks are an integral part of the American banking ecosystem, yet in recent years, they’ve increasingly come under threat. Though it would be excessive to think of them as endangered, this banking sector is in some trouble.
Recent Collapses of Regional Banks
In 2023, Silicon Valley Bank (SVB), a regional bank in California largely serving the tech sector, collapsed with little warning. Within just 48 hours, the bank plunged from a seemingly secure position into utter chaos. The sudden failure stirred up fretful questions over the integrity of banks across the U.S., and proved that even a prosperous financial institution can quickly fall from grace.
The swift collapse of SVB casts shadows of doubt among U.S consumers, prompting them to wonder whether their finds were safe in banks. Regional banks rushed to abate the mass fear. Many went the extra mile to contact their customers and personally reassure them.
More than a year later regional banks are still not immune to failure. In April, regulators closed Republic First Bank, a regional institution operating in Pennsylvania, New Jersey and New York. The bank was seized by the FDIC and was the first FDIC-backed bank to collapse in 2024. The bank had about $6 billion in assets and $4 billion in deposits as of January 31, 2024.
This most recent fall of a regional bank could signal trouble for banks in terms of customer retention, as it suggests a worrisome weakness in their structure.
Commercial Real Estate Market Exposure
Commercial real estate has long been a burden for regional banks and it’s becoming increasingly cumbersome. The primary problem is that they’re forking over so much money in the form of loans to commercial real estate landlords. Since the pandemic, more people are working remote and office vacancy rates have soared. Many landlords indebted to their regional banks are cutting costs of rent for businesses or, in some cases, selling properties at a loss. According to recent data from Trepp, a commercial real estate data and analytics company, over the next three years, $2.2 trillion in commercial real estate loan payments are due. Will those who owe be able to pay?
Regional banks will take a blow if not; they account for nearly 70% of all outstanding commercial real estate loans, according to Apollo research.
“Commercial real estate is great when rates are stable and the economy is strong but when rates start to rise as they did in 2023, there is little for the banks to do but wait it out and do what they can to manage the risk,” said
Joel Pruis, senior director at Cornerstone Advisors. “[It’s] the perfect storm of rapidly rising interest rates, change in the market demand for office space and over-concentration in the lending segment.”
To mitigate this challenge, Pruis says banks must immediately triage the commercial real estate portfolio “by stressing the individual properties by rent/sq ft, vacancy, interest rate and cap rate.”
Interest Rate Hikes
The increase in interest rates in recent years is also a problem for regional banks.
“If we look back at what happened last year, and even as far back as the recession in 2007/2008, there’s a sequence of events that typically takes place to trigger a banking crisis,” said Nelson Chu, CEO and founder at Percent.”This time around, the interest rate hike was the first ball to drop, which caused a cascading series of issues.”
“In this instance, there was a liability and duration mismatch, ” Chu SAID. “They had all these loans that were actually getting paid very little that were locked up in very long maturities. Once the interest rates hiked, they were left in a position where they were earning less than they were having to pay out in order to remain competitive. The outcome of all this is almost always bank consolidation, during which banks assume the liabilities from the company base they acquired.”
To overcome this particular challenge, banks will require some serious leadership strength.
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“Mitigating this is about more than just risk management,” Chu said. “All of these firms had risk teams that were more than capable of doing their jobs. It is risk without empowerment that is a recipe for disaster. Leadership needs to allow the risk teams to have a say in broader strategy or we will continue to see this natural sequence of events versus learning from the past.”
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This article originally appeared on GOBankingRates.com: Why Many Regional Banks Could Be in Major Trouble
