KEY - Smaller Banking System Likely In Upcoming Years

2023-10-25 05:33:04 ET

Summary

• The number of commercial banks and savings institutions in the US has significantly declined over the past few years.
• Many commercial banks are now trying to shrink in size to improve their financial performance after poor third-quarter results.
• The banking industry is becoming increasingly divided between mega-banks and smaller banks, with the latter facing more challenges in the digital era.

At the end of the year 2012, according to the FDIC, there were 6,072 commercial banks in existence and 1,011 savings institutions in existence.

At the end of June 2023, there were only 4,071 commercial banks in existence, representing a decline of 33 percent. The number of savings institutions in existence fell to 574 in number, representing a decline of more than 43 percent.

It is clear that the structure of the U.S. banking system is changing and is changing drastically in this modern era of digital finance.

Bringing this trend up-to-date, we turn to an article in the Wall Street Journal by Gina Heeb titled "Smaller Banks Seek to Shrink Their Way Back to Profitability."

The essence of the article is that the third quarter banking results were so terrible, many commercial banks are presenting plans that show the banks shrinking their size in order to achieve healthier performances.

In the latest earnings period some banks saw dramatic drops in their profits: like KeyCorp (KEY) saw its profits fall by 44 percent; Citizens Financial (CFG) saw its profits drop by 32 percent; and Truist Financial (TFC) saw its profits drop by 28 percent.

One should note that the "mega" banks did not experience the same drops. Ms. Heeb reports that JPMorgan Chase & Co. (JPM), Bank of America (BAC), Wells Fargo (WFC) and Citigroup (C) collectively saw profits go up by 27 percent.

Bottom line: We are really seeing how the banking industry is bifurcating into two segments: the mega-banks and all the others.

Many analysts have predicted that this was the future of the banking industry, but now, I think, that we are really seeing how the modern era is going to work itself out.

The biggest banks are going to get bigger and the "smaller" banks are going to get fewer in number.

This is the future and the movements into digital is only going to make it worse.

One of the biggest things impacting these banks has been the rising rates of interest.

Many of the "smaller" banks had gone into longer term securities during the past several years because, generally, all interest rates were so low. Furthermore, interest rates were staying low as the Federal Reserve seemed to be content on conducting a "quantitative easing" monetary policy in order to spur the economy on during the spread of the Covid-19 pandemic.

Given this Federal Reserve policy longer-term securities seemed just about as risky as were the shorter-term securities.

So, the banks earned a few more basis points with, they believed, little or no additional risk.

Sorry....

Rates rose over the past 19 months at a very rapid pace. Many banks have suffered seriously because of this. And, as we saw in March of this year, some of the "smaller banks" failed because of the losses they faced as they lost deposits after interest rates rose.

In fact, a couple of the commercial banks that failed were pretty good size regional banks.

Other banks have been able to hand onto their longer-term securities, but these have had a dramatic impact on earnings.

And, this is one reason why 34 bank deals were made in the third quarter of 2023.

Now, these banks are having trouble keeping deposits as rates have risen in bond markets, while they have been very slow to rise in the banks.

And, there are looming troubles.

For one, many of the "smaller" banks are complaining that U.S. consumers are not as healthy as many people are claiming they are. This may be more of a geographical issue than specifically bank size.

Furthermore, there has been a substantial change in end-of-period loans for the latest quarter. Again, we are talking here primarily of the "smaller" banks.

A looming problem coming up that have a lot of these "smaller" banks worried is the looming problems in commercial real estate loans.

Bankers are warning that there may be a substantial end-of-quarter charge- off in this area of the loan portfolio.

Whereas these trends have been in place since the end of the Great Recession, the problems have grown over the past decade.

One significant thing we are finding is that the Fed's quantitative easing has been especially good for the wealthy and, as I have reported on, since the beginning of the pandemic, the wealth inequality in the United States has increased a good bit.

This impact flows over into the banking performance, because the mega-banks seem to prosper much more from the Fed's quantitative easing than do the "smaller" banks.

This action on the part of the Fed is only adding to the decline in banking institutions and to the inequalities that exist within the banking system.

As I remarked earlier, this trend is only going to continue on in the upcoming years.

This is something that investors need to pay a lot of attention to. The banking industry is going to get smaller in number...and larger in bank size. Scale in banking has always been important, but scale is playing an even bigger role in the "new" digital world.

So, investors need to be very careful here. "Smaller" banks have not performed well for many of the reasons given in this post. But, "smaller" banks are going to do even less well in the coming digital era.

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