A trio of regional banks is currently facing increasing pressure on their returns and profitability, making them potential targets for acquisition by a larger rival, according to analysts at KBW. These banks, which have between $80 billion and $120 billion in assets, find themselves in a tough spot due to their low structural returns. Among banks with at least $10 billion in assets, this group has the lowest returns, placing them in a difficult position. In order to cope with upcoming regulations, they either need to grow larger or risk struggling for years. Out of the eight banks falling within this range, Comerica, Zions, and First Horizon are considered potential candidates for acquisition by more profitable competitors. However, it is important to note that Zions and First Horizon declined to comment, and Comerica did not respond to the article. Meanwhile, two other banks in the same category, Western Alliance and Webster Financial, have managed to maintain above-peer returns, which may enable them to remain independent. However, they too could consider selling themselves. Other lenders in this zone, such as East West Bank, Popular Bank, and New York Community Bank, have higher returns and are more likely to be acquirers rather than targets.
The proposed sweeping changes by banking regulators in response to several mid-sized bank collapses this year have added to the challenges faced by regional banks. These changes will increase compliance and funding costs for institutions with at least $100 billion in assets, bringing the measures previously applicable only to the largest global banks to a lower tier. As a result, many regional banks are concerned about the impact of new rules and the risk of a recession on loan losses, particularly in the commercial real estate sector. While the KBW Regional Banking Index shows a 21% drop in the shares of regional banks this year, recent weeks have seen a slight upward trend due to a decrease in concerns over inflation. Nonetheless, these banks are still burdened by uncertainties surrounding the new regulations.
In light of the new regulations, KBW analysis suggests that banks will eventually cluster into three groups to optimize their profitability based on their asset size. The three groups are: banks with assets above $120 billion, banks with assets between $50 billion and $80 billion, and banks with assets between $20 billion and $50 billion. Smaller banks with less than $10 billion in assets have advantages tied to debit card revenue. This means that smaller institutions should aim to grow to at least $20 billion in assets to offset the potential loss in revenue. The challenge for banks within the range of $80 billion to $90 billion, such as Zions and Comerica, is that the market assumes they will soon face the burdens of operating as $100 billion-asset banks. This assumption leads to a compression of their valuations, making them vulnerable to acquisition.
On the other hand, larger banks that have strong returns, including Huntington, Fifth Third, M&T, and Regions Financial, are well-positioned to grow through acquiring smaller lenders. While there could be differing opinions on the matter, KBW analysts downgraded the U.S. banking industry in late 2022, months before the regional banking crisis occurred. KBW is known for its expertise in determining the composition of banking industry indexes. The analysts also believe that banks in the industry are waiting for regulatory clarity and stabilized interest rates before actively pursuing consolidation. Nonetheless, consolidation has historically been a recurring theme in the banking industry, with banks adapting to the rules and regulations in order to thrive.
Regional banks within the $80 billion to $120 billion asset range are facing challenging times in terms of returns and profitability. The pressure from upcoming regulations has made them potential targets for acquisition by larger, more profitable competitors. While banks such as Zions, Comerica, Western Alliance, and Webster Financial may have different paths ahead, the industry as a whole is likely to see consolidation in the near future. The optimization of profitability based on asset size and the implications of new regulations are factors that will shape the landscape of regional banking. As the industry waits for clarity on regulations and interest rates, it is crucial for banks to carefully consider their strategies and position themselves for success in this rapidly evolving environment.
Leave a Reply