The Struggles Faced by Regional Banks and the Potential for Acquisition

Regional banks with assets between $80 billion and $120 billion are currently facing mounting pressure on their returns and profitability, making them potential targets for acquisition by larger competitors. Christopher McGratty, an analyst at KBW, highlights that this group of banks has the lowest structural returns among institutions with at least $10 billion in assets. This puts them in a precarious position, where they must either grow larger to cope with impending regulations or prepare for years of struggle.

Among the eight banks falling within this category, Comerica, Zions, and First Horizon appear to be the most likely acquisition targets for more profitable rivals. However, Zions and First Horizon have declined to comment on these speculations, while Comerica has not yet responded to the article. Conversely, Western Alliance and Webster Financial, both of which have achieved above-peer returns, have the potential to remain independent but could also consider selling themselves.

Meanwhile, other regional banks such as East West Bank, Popular Bank, and New York Community Bank have higher returns and may actually become acquirers rather than targets. KBW’s analysis, which considers the impact of forthcoming regulations, supports these conclusions. McGratty emphasizes that not all banks are equally profitable, and the demands for scalability cannot be overlooked.

Regulatory Changes and their Effects

Banking regulatory bodies have proposed a comprehensive set of changes in response to the collapse of three midsized banks earlier this year, caused by higher interest rates and deposit runs. These changes extend measures previously applicable to major global banks to institutions with at least $100 billion in assets. Consequently, compliance and funding costs for these institutions are expected to increase.

Despite the challenges, regional banks have experienced a recent resurgence in their stock prices due to a reduction in concerns about inflation. However, the sector remains burdened by anxieties surrounding the impact of new rules and the potential recession-related risks associated with loan losses, particularly in the commercial real estate sector.

The Future of Regional Banks

According to KBW’s analysis, the banking industry will eventually restructure into three distinct groups based on asset size, aiming to optimize profitability. These groups include banks with assets above $120 billion, $50 billion to $80 billion, and $20 billion to $50 billion, respectively. Banks with less than $10 billion in assets have certain advantages tied to debit card revenue, which means that smaller institutions should aim to reach at least $20 billion in assets to offset this loss.

The predicament faced by banks with assets ranging from $80 billion to $90 billion, such as Zions and Comerica, lies in the market’s assumption that they will soon face the challenges of being $100 billion-asset banks. This expectation is reflected in the compression of their valuations. On the other hand, larger banks with strong returns, including Huntington, Fifth Third, M&T, and Regions Financial, are well-positioned to expand through the acquisition of smaller lenders.

Although some analysts have a more optimistic outlook, KBW downgraded the U.S. banking industry in late 2022, several months before the regional banking crisis. The firm is renowned for its role in determining the composition of indexes that track the banking industry. While banks are currently awaiting clarity on regulations and interest rates before actively pursuing deals, consolidation has historically been a common theme in the industry. McGratty states, “We’ve seen it throughout banking history; when there are thresholds in terms of asset size, banks find ways to adapt.”

The struggles faced by regional banks in terms of returns and profitability have put them at risk of acquisition by larger rivals. The looming regulatory changes and potential recession-related risks have further compounded their challenges. While some banks may retain their independence or even become acquirers themselves, the outlook appears to favor larger, more profitable institutions that can pursue expansion through strategic acquisitions. Only time will tell how these dynamics will unfold within the regional banking industry.

Business

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