August 15, 2023

It’s been a tough stretch for regional banks.

After what can only be called a disastrous couple months following the banking crisis in March, the community-focused segment of the lending industry had been trying to dig themselves out of a hole they didn’t necessarily dig. 

SPDR S&P Regional Banking ETF (KRE) — Year to Date

Last week they got kicked where it hurts… 

Right in the ratings.

On August 8, Moody’s Investors Service cut its ratings on 10 small to mid-sized banks. (It also hinted that it may downgrade a few of the bigger boys.)

The move was evidence of an already struggling industry. The cut appears to have taken the wind out of the sails of what little momentum they’ve built back up.

SPDR S&P Regional Banking ETF (KRE) — August 2023

To say the economy is pretty fragile right now is probably a pretty big understatement. Consumers are struggling. Inflation is persisting well above the Fed’s target. And credit is getting very tight. 

But the continued pressure on the regional banking sector is adding even more stress to the mix.

The Regional Banking System is Key

The vast majority of commercial banks that have ever operated in the U.S. have disappeared.

That’s from a 2021 report by the Federal Reserve Bank of St. Louis. It went on to elaborate… 

Since its all-time high of 30,456 in 1921, the bank population had declined to only 4,377 at the end of 2020, a decline of about 86%.

Some of those banks were big guys. But by and large most were smaller regional institutions. And that’s really a troubling loss…

Small to mid-sized and regional banks are better able to service small businesses — the sector that makes up 60% of the economy. They often have much better insights into their customers’ needs than would a bank likeWells Fargo. (The “Bank of Bird-in-Hand” — I’m not kidding — offers banking services to the Amish including loans for homes and farms along with other services that target that community’s specific needs.)

Tally the numbers up and you might be shocked. According to data from Goldman Sachs, small- to medium-sized banks account for: 

• 45% of consumer lending…
• 50% of US commercial and industrial lending… 
• 60% of residential real estate lending and… 
• 80% of commercial real estate lending… (coming back to this one!)

These banks have now been weakened by deposit flight. Depositors withdrawing their money in search of higher returns. And this drain on deposits has weakened those still standing substantially.

Big Threats from CRE

Reread that last bullet point.

The Wall Street Journal recently reported:

Nearly $1.5 trillion in commercial mortgages are coming due over the next three years, according to data provider Trepp. 

Over 85% of CRE loans are “interest only” with landlords refinancing or selling the property when the loan comes due. 

That means these regional banks are heavily exposed to what could be a sinking sector. If terms on these loans can’t be renegotiated a lot of already struggling regionals are going to have to write down the value of their holdings and set aside even more cash (which they don’t have) to cover the losses.

The downgrade by Moody’s is a serious sign of potential trouble. 

The Federal government was just taken down a notch by Fitch from AAA to AA+. Their response was predictably to criticize the agency.  Regional banks don’t have any such ability. 

They have to operate in the real world. 

Humbly yours, 

Tim Collins
Editor, Streetlight Daily