The winners and losers in a bank scare become clear

About the author: Brian Graham Co-Founder and Partner at Klaros Group, an advisory and investment firm focused on the future of financial services.

A tsunami of banking information has hit the past few days and weeks: first-quarter earnings, flows into government money market funds and Treasuries, regulatory reports on recent bank failures, enforcement actions, and of course the silicon failures and decisions of Valley Bank, Signature, and most recently First Republic.

The cause of this banking crisis could not be simpler. Many banks forget that interest rates can go up or down. When the Federal Reserve raised interest rates to fight inflation, those banks suffered losses. For most people, losses are an issue, but they are not existential. But for a handful, like SVB and First Republic, the losses from mismanaged risk were large enough to drive them into economic bankruptcy. Going forward, many banks will need to raise capital to fill the holes in their balance sheets, which could be painful for existing shareholders. And while more bank failures can’t be ruled out, there probably won’t be too many SVBs or First Republics waiting in the wings.

From this dissonance, a clear picture emerges of both long-term winners (punch line: the largest banks, in particular JPMorgan) and losers (primarily regional banks with assets between $75 billion and $250 billion).

The biggest and most direct winner is the three banks that put themselves in a position to pick up the pieces. First Citizens bought what was left of the SVB; Its stock has nearly doubled. New York Community Bank acquired the remainder of Signature; Its stock jumped 50%. Over the past weekend, JPMorgan acquired First Republic; Despite its massive size (First Republic accounts for only about 5% of the combined company’s assets), JPMorgan stock has jumped in the wake of its acquisition. It turns out that being one of the few banks able to bid on a forced sale under intense time pressure is a recipe for getting a good deal.

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Bank failures are simultaneously reshaping the deposit market. Higher interest rates have already created incentives for depositors to transfer money from low-yielding checking accounts. The shock of the SVB failure has prompted companies, institutions and other businesses with significant balances above the $250,000 FDIC insurance cap to reexamine where they keep their money. Money moves for higher returns and greater security (to “too big to fail” banks, to fully insured accounts offered by deposit networks, to direct investment in treasury bonds and government money market investment funds). Since the SVB fiasco, deposits industrywide have fallen by more than $130 billion (even as bank assets rose nearly $200 billion in that period), while more than $400 billion of new money has been poured into money market mutual funds. government.

Once again, JPMorgan emerges as a clear winner. In the first quarter, only JPMorgan and US Bancorp, among the 35 largest publicly traded banks, saw an increase in non-interest deposits (such as checking accounts) as large commercial depositors sought safety. The losers from this rapid shift in depositor behavior are the regional banks which were heavily dependent on such deposits and yet, in the wake of the SVB, are not seen as ‘too big to fail’. Every major and regional bank other than JPMorgan and US Bancorp has seen large inflows of non-interest deposits, totaling more than $150 billion. They all have to replace the lost “free money” with high cost financing. To be clear, this is a profitability issue, not a solvency issue. These banks are likely to see a permanent increase in the cost of funds, especially for the larger banks.

In addition to deposit shifts, this latest banking crisis – like previous ones – will have political and regulatory ramifications. Remember, Congress increased the threshold for stricter regulation in 2018 from $50 billion in assets (as defined by the Dodd-Frank Act in the aftermath of the global financial crisis) to $250 billion. The biggest banks have been under this intense supervision all along. But each of the last three bank failures involved banks with assets between $100 billion and $250 billion. The Fed’s report on the SVB failure explicitly recommends lowering the threshold for further scrutiny to $100 billion. No matter where the new threshold ultimately lands, a tougher regulatory environment awaits some banks.

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There is really no winner when regulation increases, although both domestic banks and “too big to fail” banks are likely to see little change in their respective regulatory burdens. However, the losers from the looming tougher regulations are clear. Regional banks with assets of $75 billion to $250 billion face a very different and more challenging regulatory environment, more in line with what the largest banks have faced for years. The current disincentive to exceeding $250 billion will evaporate.

Across the board, JPMorgan is the biggest winner, while the biggest losers are regional banks, which are facing rising funding costs and a tougher regulatory environment.

At the end of 2022, there were 29 US banks with assets between $75 billion and $250 billion, with combined assets of $4.6 trillion. They made up just over a fifth of the entire US banking sector. This number will collapse in about 18 months, which will lead to a major restructuring of the banking industry. Some of these banks will join forces to join the ranks of the largest, given that any disincentive to staying below $250 billion in assets disappears. Some will shrink by selling off assets and lines of business to stay away from the threshold of stricter regulation. Smaller banks are likely to rush into consolidation to offset the higher costs of regulation while staying clear of the new regulatory threshold, resulting in a significant increase in banks with about $50 billion in assets.

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The millions of consumers and businesses who rely on these banks need to prepare for major disruption and change.

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