A Brewing Financial Storm: The Struggle of Smaller Banks

By Ethan Bennett Apr 28, 2024

Unveiling the widening financial gap between the nation's biggest banks and their smaller counterparts, as falling interest income and failing real estate market hit regional lenders harder.

First-quarter earnings reports underscore an emerging truth in the financial world: the larger the bank, the better its performance. Many lenders, regardless of their size, grappled with falling growth or outright reductions in net interest income, the main driver of profitability. However, large American banks were able to counteract this with robust revenue growth from other sources – especially investment banking and capital market trading.

This is a luxury smaller banks don't have, and their earnings reports reflected this. They fight tooth and nail for deposits as the Federal Reserve's halt in interest rate hikes has effectively limited how much they can charge for loans. Moreover, the turbulent commercial real estate market, which contributes significantly to regional banks' loans, has posed additional challenges. These banks heavily rely on real estate loans or real estate as collateral, more so than the larger banks.

Essentially, there's a widening financial gap between the country's biggest banks and all other lenders - a rift only highlighted by last year's tumultuous events and continuing into the present. According to Charles Calomiris, a finance professor at Columbia University, smaller banks are severely at risk and their future business models are uncertain.

The recent quarter revealed a weak demand for loans that could squeeze net interest income if loan rates remain high. Large banks, however, have a safety net in their trading revenue, which smaller banks lack.

Top banks in the country, such as JPMorgan Chase, Citigroup, Wells Fargo, and Bank of America have all outperformed quarterly earnings estimates on the back of robust performances in investment banking, trading, and other non-consumer banking activities. On the other hand, deposits largely migrated to these big banks when regional banks faced balance-sheet issues last year.

High interest rates and the shift to remote work have added to the woes of the commercial real estate market, particularly impacting the value of office buildings and multi-family properties. In the wake of these challenges, smaller local banks that primarily deal with real estate are exposed to mounting financial risks.

New York Community Bancorp a case in point, with shares plummeting 70% this year, following the bank's need for a $1 billion cash infusion to stay afloat due to its exposure to bad commercial real estate loans.

Stocks of the banking powerhouses like JPMorgan, Citi, Wells, and Bank of America each soared between 13%-18% in the first quarter. In contrast, the KBW Nasdaq Regional Banking Index, reflecting the overall regional banking sector, dipped by 6.6% in the same period. This stark contrast further illustrates the struggle of regional banks against their larger counterparts.

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