Date: 08/22/2023
Author: Mr. X
S&P Global downgraded Associated Banc-Corp and Valley National Bancorp on Monday because of higher risk of brokered deposits and funding risks. UMB Financial Group, Comerica Bank, and KeyCorp also got downgraded based on large deposit outflows and higher interest rates.
S&T Bank and River City Bank also got a downgrade to “negative” because of their exposure to commercial real estate. The weakness of the commercial real estate market was one of the factors that Federal Reserve members discussed in their recent minutes.
The move by S&P Global follows the downgrades from Moody’s with 10 banks having their ratings cut and six others put on review. The main factor is the quantitative tightening regime being implemented by the Federal Reserve.
Regional banks are in a delicate situation because there is not the same assurance of a bailout and financial help. For this reason, some midsize banks have been calling for the FDIC to guarantee all their deposits for two years, instead of just the $250,000 that it guarantees now. We are still living in the aftermath of the collapse of Silicon Valley Bank and Signature Bank.
Minnesota Fed President Neel Kashkari has called for increasing the capital requirement for banks with assets exceeding $100 billion. “Personally, I don’t think it goes far enough,” he said about actions taken to shore up regional banks thus far. “While it’s a step in the right direction, I believe we should take more significant actions.” He expressed concern that regional banks could be put under strain as interest rates continue to increase.
What’s interesting here is that Kashkari is one of the more hawkish members of the Fed when it comes to interest rates. He is likely to be among those urging further increases. However, he’s not ignorant of the risks. “[T]he risk lies in the potential scenario where inflation is not entirely under control, and we are required to raise rates further in order to bring it down,” he said. “In such a case, banks could face more losses than what they are currently experiencing. And these pressures could resurface in the future.”
Remember, that Kashkari played a prominent role in the Troubled Asset Relief Program during the financial crisis. His role in TARP led to a relatively high profile for a central banker. He should be familiar to anyone who has seen Too Big To Fail – not to mention his failed run to be California’s governor.
Given that experience, what can we say about what regional banks are going to do next? If the Fed defies expectations and raises interest rates again at the soonest opportunity, it will increase the pressure on regional banks. However, regulatory uncertainty over new rules for capital requirements is making it harder for regional banks to make the obvious play – merge with each other and with bigger banks to remove the risk. According to Timothy Adams, CEO of the Institute for International Finance, everything is “frozen in place until they know what the rules of the road are.”
The result is that regional banks are uniquely vulnerable. The Federal Reserve wants to bring inflation down to 2%, which seems an unrealistic target. Though inflation is slowing, the high mortgage rate and the pressure on regional banks makes this target seem like something out of Moby Dick rather than sensible economic policy. If the Fed does go for the white whale and put everything into bringing inflation down to 2%, regional banks become the weak spot for the American economy. Trapped into inaction because of new requirements, we may need another federal program to save the banks that are not “too big to fail” but too small to succeed in this financial environment.
Investors looking for a cautious portfolio should run, not walk, away from such banks.
Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing
