Are US Regional Banks Still Posing a Threat to the US Banking System?

Looking back to Friday 10th March 2023, Silicon Valley Bank, SVB was closed down by US regulators, this closure was closely followed by regulators closing down Signature Bank on Sunday 12th March 2023. This was closely followed by a run on the San Francisco based First Republic Bank, resulting in a USD30 Billion capital injection from a group of major banks. 

However, the bank was in such a poor state that it was eventually closed on May 1st 2023 and sold to JPMorgan Chase. The subsequent fall-out had reverberations being felt across the Atlantic where in Switzerland Credit Suisse AG, who was now suffering liquidity problems was taken over by Union Bank of Switzerland AG. 

The failure of Silicon Valley Bank and Signature Bank is not just about their management, but is also a failure in regulation and supervision by the federal authorities. Whilst some argue the failures were due to Donald Trump in 2018 signing into law a bill reducing scrutiny over banks with assets under USD250 Billion, other experts have provided a number of red flags that despite a reduction in supervision should have alerted the federal regulatory authorities.

As a result, The Bank Term Funding Programme (BTFP), a lender of the last resort facility was created in March 2023 in the aftermath of the failure of Signature Bank and Silicon Valley Bank. As of close of business May 3rd 2023, banks had used this facility to the tune of USD75.8 Billion down by circa USD5 Billion from the week before.

However, whilst markets remain somewhat upbeat regarding the state of US regional banks, some experts are warning that more regional banks may yet fail because under the surface there are various problems brewing. In recent years, regional banks have become a force in commercial real estate which analysts suggest could be a further source of trouble for the industry.

The problems affecting the commercial real estate industry in the United States are higher interest rates, which are cutting into the value of properties, working from home has also contributed to a decline in office values and circa USD1.5 Trillion of US commercial property debt will come due during the year 2025. Thus, many US banks have become more vulnerable to risk if a decline in commercial properties takes place. 

Recently released figures show the number of US Banks exceeding the 2006 FDIC’s (Federal Deposit Insurance Corporation) guidance on commercial real estate concentration* has reached the figure of seven hundred, more than double that of 2021. For information as of 31s March 2023 the FDIC was insuring circa 4,700 banks. 

*In 2006, the FDIC introduced guidelines affecting risk management deficiencies and loan concentration to banks regarding commercial property loans. The upshot is that those exceeding those guidelines are subject to higher capital levels, increased practices within risk management and greater supervisory scrutiny.

Some smaller banks are already reducing their exposure to commercial real estate and in order to shore up liquidity are already off-loading this business from their balance sheets, an example of which is PacWest Bancorp, who are in the process of selling USD2.6 Billion in construction loans. Indeed, expert analysts in this sector advise that on average these smaller banks have circa 14% of their total assets exposed to commercial real estate, but in some cases this could be as high as 40%.

The same experts suggest that any further failures by regional banks would affect landlords and property developers alike (especially those who are viewed as lower quality), by making credit even more difficult to access. Figures show that office values are on average down by 27% having fallen further in the last two months, and across the board the average commercial property is down 15%.

A credit contraction may well engulf the commercial property market, coupled with declining values more scrutiny should be applied to those regional banks who are heavily invested in this market. The world has already seen the fall-out from two mid-cap regional banks in the United States, further closures could indicate a run on many other regional banks, with its effects perhaps reaching far beyond the shores of the USA.