Small and midsize regional banks have fallen behind their larger counterparts lately, due to tumbling deposits and decreased lending. One of the main hurdles has been the Dodd-Frank legislation that was born out of the 2008 financial crisis, and put strong federal oversight on most financial institutions. However, things are about to get better for the regionals.
New legislation awaiting President Trump’s signature will include breaks for smaller banks that essentially eliminates the designation of systemically important financial institution for all but the biggest banks, by raising the threshold for that classification from $50 billion to $250 billion in assets. The Economic Growth, Regulatory Relief and Consumer Protection Act, will leave fewer than 10 big banks in the United States subject to stricter federal oversight, relieving pressure on institutions like BB&T BBT, SunTrust Banks, and HSBC USA. The bill also gives regulators more discretion in deciding when to require stress tests of capital adequacy for banks with $100 billion to $250 billion in assets in the event of another crisis.
2017 was rough on some smaller firms as 10 of 22 major regional banks experienced declining U.S. deposits on the year, compared with only two years before. The smallest U.S. banks, which tend to be community lenders with a handful of branches, have seen deposits decline as well. Meanwhile, the three biggest banks added a combined $118 billion in U.S. deposits. As a group, the nearly two dozen regional banks added a net amount of roughly $55 billion.
2018 was off to a great start for the whole sector as the banking Industry enjoyed $56 billion in net income in Q1 2018, up 27.5% from prior-year quarter. This profit was so significant in that, even without the new cut in corporate tax rates, banks still would have earned $49.4 billion — and that, too, would have been a record. For small banks, although earnings were up, they still trailed the big banks, with profits up 18% overall and roughly 73% of community banks turning a profit on the quarter. So, it is not that smaller banks are struggling, rather, they are just being crowded out by bigger market players. But now, this upcoming rollback may be a steroid shot in the arm of regional banking.
Since Dodd-Frank was enacted, some smaller banks have purposely kept their assets below $50 billion to avoid harsher financial oversight. Now that the allowable limit has effectively quintupled, M&A activity could be spurred on. Credit Suisse argues that even with decades of consolidation, America’s banking industry is more fragmented than in other developed economies, with just half of U.S. banking assets in the four largest banks, compared to 80% or more in other nations. Banks that have scale, data, and good brands are able to leverage their advantage to grab market share, which in turn, strengthens their position even further, upping the pressure, and thus accelerating the pace of consolidation. On Monday, Fifth Third Bancorp announced that it will buy fellow bank MB Financial for $54.20 per share in a cash-and-stock deal valued at $4.7 billion. While the deal itself isn’t huge, it’s the largest since 2015, and a great sign for small and mid-size firms going forward.
Lending has also been problematic for regional banks. A study conducted by Regional Bank Coalition shows a decline of 9.8% in growth rate for total regional bank loans after the implementation of Dodd-Frank. Regional bank loans will undoubtedly bounce back from the deregulation push alone, but many have been forced to become more competitive over the last few years, and finding new ways to lend; chief among them, FinTech. GreenSky, a fintech platform focused on lending, and scheduled to go public this week, has cultivated a growing list of sizable regional banks to finance loans, including SunTrust Bank, Regions Bank, Fifth Third Bank and Synovus Bank. Overall, the banks have financed $12 billion in transactions to 1.7 million consumers.
Beyond lending, smaller banks have embraced ventures in cryptocurrencies as well. Big banks’ decision to largely shun the crypto world has given a head start to smaller lenders. So far, the Main Street banks have landed customers that are well-known in the crypto world, including the exchanges Coinbase, BitFlyer and Kraken, which allow users to buy and sell digital currency. Metropolitan Bank, for instance, has said that doing business for digital companies has allowed the company to increase fee income, which more than tripled in 2017, largely from crypto transactions.
More regulatory optimism should be in the pipeline for smaller lenders as well. Later this month, regulators including the Fed, as well as the Securities and Exchange Commission, Commodity Futures Trading Commission, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp., are expected to release a plan to water-down the Volcker Rule, which bans banks from making risky bets with depositors’ money. The office of the Comptroller of the Currency also has said that standards on unsecured loans should be relaxed to allow banks to underwrite small-ticket loans, typically sized between $500 and $5,000, over periods of 45 and 90 days, a field where regional banks such as US Bancorp, Regions Financial and Fifth Third had been particularly active.
Things have been good for most regional banks, but if the Trump administration continues to rally bipartisan support behind smaller lenders, larger deals and new technological ventures could boost main street banking profits even further.
We added Long Financials and Long Regional Banks to MRP’s list of investment themes on December 23, 2016. Our rationale at the time was that a Trump presidency would result in deregulation that would benefit these financial institutions. Since then, the Financials ETF (XLF) and the Regional Banking ETF (KRE) have returned 19% and 15%, respectively, against the S&P 500’s 21% gain over the same period. As the impact of looser regulation kicks in, financials should outperform the broad market.