Consolidation Tsunami: Mergers Looming Over American Banking Landscape

 

 

Bank collapses such as Silicon Valley Bank, Signature Bank, and now First Republic Bank are omens of impending crisis. To survive, American banks, particularly small ones, will have to combine, like they have in previous crises.

 America's banks are in hot water as competition and funding costs rise, leaving them struggling to stay afloat. According to earnings reports that have been posted after April 14th, behemoths such as JPMorgan Chase and Bank of America attracted deposits while providing modest interest after the failures of Silicon Valley Bank (SVB) and Signature Bank in March. In contrast, many smaller and medium-sized banks are facing increasing competition for customers as well as rising expenses associated with obtaining credit. On the 18th of April, Western Alliance, a lender that has assets totaling $71 billion, stated that it has lost 11% of its deposits so far this year. Banks will need to offer higher interest rates on deposits in order to entice customers to return; in the interim, many financial institutions have resorted to short-term loans, including those from the Federal Reserve, which are subject to the high interest rates that are currently prevalent. On the other hand, many of the assets that banks hold have low yields and cannot be sold without triggering losses. There will soon be a significant hit to profitability.

According to the best evidence available, additional banks were scheduled to report their earnings this month. However, the market has already rendered a verdict: the combined book value of America's banks is roughly equivalent to their current market value, despite having opened the year trading at a nearly 40%  premium. Consolidation is a tried-and-true solution to financial crises that has been used repeatedly over the past four decades. This is likely to be the outcome of their low valuations, along with an environment in which size matters.

 

Bigger, Better, and Bailouts

 

There are 4,700 financial institutions, which equates to one for every 71,000 people living in the United States. This looks excessive to people living in the European Union, where there is only one bank branch for every 85,000 inhabitants. However, this number is at an all-time low: in 1984, when comparative data were first collected, the population was significantly lower, and there were nearly four times as many institutions. Since then, there has been practically nonstop consolidation throughout the banking industry. After a prolonged crisis among savings and loan associations (S & Ls), which are lenders that specialize in mortgages, which reached its apex in the late 1980s, the industry experienced the most significant wave of mergers. It left behind a lot of carcasses, which the more powerful banks could pick over. Alterations to the rules, such as the elimination of limitations placed on financial transactions that crossed state lines, were another factor that contributed to the expansion of banking institutions.

There are a number of similarities between that time and the present. The rise in interest rates caused many S & Ls to fail since their funding costs increased at the same time, but their mortgage-loan books brought in low, fixed rates of interest. If their assets had been marked to market at one point, over two-thirds of  S & Ls (savings and loan associations) would have been declared bankrupt. The difficulties with the banks' balance sheets of today are not as serious as they were in the past, but their nature has not changed. At the end of the year 2022, more than 400 banks with a total asset value of nearly $4 trillion had unrealized losses on their securities portfolios that were worth at least fifty percent of their primary equity. If you take into account their fixed-rate loan books as well as the potential future losses that could result from lending against commercial property, the hole would be even larger.

At the same time, smaller financial institutions run the risk of having the regulatory advantages they currently enjoy taken away from them. Even the securities that the bank considers to be "available for sale" and that are designed to be a source of quick cash in an emergency are often exempt from having to be marked to market when it comes to the calculation of the regulatory capital that the bank must have. This exemption applies to banks that have assets that are less than 700 billion dollars. Those with a market capitalization of less than $250 billion are excluded from some of the more stringent liquidity regulations, stress tests, and failure preparation. This regulatory regime, which is very light-touch, is currently being examined by both domestic and international regulators. The Basel Committee on Banking Supervision, which is responsible for writing the worldwide banking rulebook, is currently doing research to determine what may be learned from the failure of the SVB bank. The depositors of the SVB bank were rescued despite the fact that the bank was too small and concentrated on the local market to be subject to the most stringent regulations. In the nation's capital, the Congress and the Federal Reserve are carrying out  a fresh scrutiny on the loosening of the restrictions for medium-sized banks in 2018 and 2019.

It is likely that the banks that are on the cusp of substantial regulatory thresholds will be the ones to drive the most dramatic changes in the structure of the market. There are 20 banks that have assets ranging from one $100  to $250 billion. If the penalty for exceeding the $250 billion threshold is decreased, many banks may determine that merging together is beneficial. By doing so, they would be able to reduce the impact of the rising expenses of complying with regulation across a larger enterprise, while simultaneously increasing the likelihood that their depositors would be rescued in the event of an emergency. The strategy of gambling for resurrection by taking enormous risks was one of the factors that contributed to the severity of the S & L (savings and loan) crisis during the 1980s, and regulators are likely to look favorably on mergers and acquisitions that gobble up zombie banks. If this is the case, the most recent financial crisis will serve as the most recent stimulus for banks to expand their operations.

For American banks, the message is very clear: when the market's in flux and the rules are unclear, banks that merge will have nothing much to fear. Regulators will smile upon a merger that's sound. So, it doesn’t make any sense to be the one left standing alone, unbound.

 

Notes

 

Azhar , S., & Nguyen, L. (2023, March 14). U.S. Banking Behemoths Attract Flood of Deposits After SVB Collapse. Retrieved from Reuters: https://www.reuters.com/business/finance/us-banking-behemoths-attract-flood-deposits-after-svb-collapse-sources-2023-03-14/

Banco de España. (n.d.). The Basel Committee on Banking Supervision (BCBS). Retrieved from https://www.bde.es/bde/en/areas/supervision/actividad/BCBS/El_Comite_de_Su_13e462eab2e4961.html

Corporate Finance Institute. (2023, March 10). Savings and Loan Crisis. Retrieved from https://corporatefinanceinstitute.com/resources/commercial-lending/savings-and-loan-crisis/

Cox, J. (2023, May). The First Republic Deal Has Come at a Crucial Point for the Markets and Economy. Retrieved from CNBC: https://www.cnbc.com/2023/05/01/the-first-republic-deal-has-come-at-a-crucial-point-for-the-markets-and-economy.html

Saini , M., & Siddarth , S. (2023, April 5). Western Alliance Bancorp's Deposits Fall 11% on U.S. Banking Crisis Fallout. Retrieved from Yahoo News: https://www.yahoo.com/lifestyle/western-alliance-bancorps-deposits-fall-173509606.html

The Economist. (2023, April 20). The Prize of Size: Why America Will Soon See a Wave of Bank Mergers. Retrieved from https://www.economist.com/leaders/2023/04/20/why-america-will-soon-see-a-wave-of-bank-mergers