2023 was an eventful year for community bankers.
The failures of Silicon Valley Bank, Signature Bank and First Republic Bank last spring and subsequent calls for capital hikes were top-of-mind for the banking industry all year. Recessionary fears continued amid concern that the Federal Reserve could navigate a soft landing.
Though the overall M&A market was down from 2022, multiple financial technology firms acquired community banks. Regulators also continued to sound the alarm on the rise of artificial intelligence and promulgate new rules. Community bankers and their advocates filed lawsuits against the FDIC over its non-sufficient-funds policy and the Consumer Financial Protection Bureau for its Section 1071 small business lending rule.
With a toast to 2023, BankBeat.biz has compiled the five stories that especially captivated the industry during the previous 12 months:
1. BANK FAILURES ROIL REGIONAL, COMMUNITY BANKS
The banking world was thrust into uncertainty last spring following the failures of large regional banks Silicon Valley Bank, Signature Bank and First Republic Bank.
Financial regulators closed Santa Clara, Calif.-based Silicon Valley Bank on March 10 and took control of its assets following an unsuccessful capital raise. The $209 billion bank’s failure was partially caused by its overreliance on long-term Treasuries bonds. As the Federal Reserve raised interest rates, the bank sustained heavy financial losses as it sold assets at a steep discount to their initial purchase prices.
On March 12, the New York Department of Financial Institutions closed $110 billion Signature Bank after the New York City-based commercial bank and major lender to the crypto industry faced a crisis triggered by the SVB failure.
That same week, a group of 11 of the largest U.S. banks deposited $30 billion into troubled San Francisco-based First Republic Bank. However, the infusion wasn’t enough to save the beleaguered bank, which failed on May 1. The $232 billion bank is the second-largest to fail in U.S. history, trailing only $307 billion Washington Mutual Bank, which failed at the height of the 2007-08 financial crisis.
Despite the string of failures, community banks generally remained stable as their business models were drastically different from the large regionals. Still, compressed net interest margins pressured bank balance sheets as yields remained between 3 and 4 percent while cost-of-funding was typically at least 5 percent.
Two community banks failed later in 2023 for unrelated reasons. On July 28, the Kansas Office of the State Bank Commissioner shuttered Elkhart, Kan.-based Heartland Tri-State Bank. Syracuse, Kan.-based Dream First Bank later assumed all of Heartland’s deposits and virtually all of its assets.
A report from Bloomberg Businessweek later attributed Heartland Tri-State’s failure to CEO Shan Hanes’ involvement in a cryptocurrency scam. According to the report, which was based on interviews with three anonymous sources, Hanes asked a client of the $139 million bank if he could borrow $12 million to address a crypto problem. The CEO reportedly said someone was trying to help him invest money in crypto, but there had been trouble with the wire payments. Despite Hanes telling the client that bank money was not involved, two sources told Bloomberg that it was.
Though the client declined Hanes’ request, he reportedly learned a week later that Hanes had in fact made the $12 million wire transfer. The client contacted a director of the bank’s board and warned that the bank could be at risk.
On Nov. 3, the Iowa Division of Banking closed Sac City, Iowa-based Citizens Bank after the bank incurred significant unrealized losses to its commercial trucking lending program. IDOB tendered receivership of the bank to the FDIC. Following the failure, the FDIC entered into a purchase and assumption agreement with Emmetsburg-based Iowa Trust & Savings Bank to assume all Citizens Bank loans along with consumer, business and public deposits.
The first Iowa-based bank to fail in 12 years, Citizens Bank suffered especially high loan losses in the third quarter of 2023. Citizens Bank reported $4.43 million in charge-offs through the third quarter of this year, up from $518,000 at the end of the second quarter. The bank also reported $4.81 million in loan and lease loss provisions through the third quarter, up from $220,000 the previous quarter.
2. RISING REGULATORY TIDE
Community bankers and their advocates played an active role in attempting to prevent legislation they say would harm the industry.
In July, the Minnesota Bankers Association and Annandale, Minn.-based Lake Central Bank filed a federal lawsuit against the FDIC alleging the agency lacked statutory authority to require banks to retroactively evaluate their NSF policies. The lawsuit, filed July 20, alleges that the FDIC lacked the authority to change existing bank disclosure requirements and issue an Unfair and Deceptive Acts or Practices rule on NSF fees. The lawsuit also accused the FDIC of violating the Administrative Procedure Act by bypassing input from regulated financial institutions and the public before issuing the rule.
In September, the FDIC defended the regulatory guidance. The agency called for the dismissal of the lawsuit, calling it “a transparent effort to avoid the possibility of future enforcement actions related to charging multiple NSF fees, regardless of the risks posed by those practices.” A motion hearing in the case is slated for March 13.
The future of the CFPB remains uncertain amid an ongoing lawsuit alleging the agency’s funding structure is unconstitutional. In October 2022, a three-judge panel in the U.S. District Court for the Western District of Texas ruled that the agency’s funding structure is unconstitutional because it draws funding from the Federal Reserve instead of Congress.
The court’s ruling invalidated the bureau’s 2017 payday lending rule limiting the collection options for payday lenders. Following the ruling, the Biden administration asked the Supreme Court to hear the case, which the high court has since agreed to do.
In March, the U.S. District Court for the Southern District of New York unanimously ruled that the CFPB is constitutionally funded, setting up competing legal rulings for the Supreme Court to consider. The court is expected to make a final decision in the case this spring.
In September, a U.S. district court issued a nationwide injunction blocking the implementation of the CFPB’s Section 1071 rule until the Supreme Court rules on the funding case. Section 1071 would require lenders to collect and report information on the race, sex and ethnicity of the principal owners of the small business applicant as well as the company’s gross annual revenue. Under the rule, the CFPB would require lenders that originate at least 2,500 small business loans to collect data starting on Oct. 1, 2024. Lenders that originate at least 500 loans will need to begin collecting information on April 1, 2025, and those that originate at least 100 annually must collect data starting on Jan. 1, 2026.
Last April, Texas Bankers Association and Rio Bank, McAllen, Texas, filed a lawsuit against the CFPB, challenging Section 1071. The American Bankers Association joined the lawsuit the following month.
Last spring’s bank failures also sparked regulatory changes. Following the failures, the FDIC lifted its $250,000 insurance limit on deposits for customers of the two banks to prevent other banks from failing. The Federal Reserve also provided easier terms on short-term loans taken by cash-strapped banks. In the days following the March failures of Signature Bank and Silicon Valley Bank, banks borrowed nearly $153 billion from the Discount window.
In the ensuing months, regulators unveiled plans to require banks to issue more long-term debt as part of their living wills. The proposal, issued Aug. 29 by the FDIC, Federal Reserve Board of Governors and Office of the Comptroller of the Currency, would require banks with at least $100 billion in assets to have a minimum amount of eligible long-term debt — 6 percent of total risk-weighted assets or 3.5 percent of average total assets, whichever is greater — to absorb losses in the event of a failure.
According to the FDIC, the proposal would grant it greater flexibility to either transfer deposit liabilities to an acquirer, or utilize a bridge depository institution to provide additional time to find a resolution. The proposal was supported by the Independent Community Bankers of America but opposed by the American Bankers Association.
3. RECESSION: TO BE OR NOT TO BE?
The past 12 months have brought endless speculation of whether the Federal Reserve will be able to navigate a soft landing as it raised interest rates to between 5.25 and 5.5 percent from near-zero in March 2022.
Sparked by aggressive interest rate hikes from the Federal Reserve Open Market Committee, inflation has fallen closer to the committee’s long-term 2 percent target from its decades-high reading of 9.1 percent in June 2022. The FOMC again paused interest rates at its December meeting and signaled that three rate cuts are likely in 2024.
Despite the Fed’s continued restrictive policy, Real GDP grew at a nearly 5 percent annualized clip in the third quarter of the year, and unemployment remains low at under 4 percent.
The stock market has also enjoyed a strong year: The Dow Jones Industrial Average, S&P 500 and Nasdaq indexes have all increased by double digits. Though the housing market has weakened amid high interest rates, that softening has signaled a return to average from historically high figures, CliftonLarsenAllen Managing Principal of Industry Susan Roberts said during a Dec. 6 webinar.
Still, bank executives lack confidence in the direction of the economy as interest rates remain high. Thirteen percent of bank CEOs say their local economy is already in a recession, while another 43.3 percent anticipate a recession in early 2024, according to Creighton University’s December survey of bank CEOs in rural areas of a 10-state region dependent on agriculture and/or energy.
Community bankers were more optimistic about the economy but still saw a recession as inevitable, according to an Oct. 10 report from the Conference of State Bank Supervisors. Eighty-seven percent of community bankers said the economy is either entering a recession or soon will, down from 95 percent last quarter.
4. RISE OF FINTECH, AI
The use of technology in banking continued to grow in 2023, as regulators took a closer look at the rise in artificial intelligence and associated potential risks to the banking industry.
Two acquisitions involving Upper Midwest-based banks embodied the trend. In February, San Francisco-based fintech Metallicus, Inc., announced it was forming a bank holding company and planned to acquire Illinois-based State Bank of Nauvoo. Metallicus, which develops products on the blockchain, was forming FBBT Holdings, Inc., which organizers said would expand banking and financial services to underserved customers in emerging tech industries.
In early 2023, Houston-based cryptocurrency trading and custody platform LevelField Financial announced its pending acquisition of Illinois-based Burling Bank. According to a press release, LevelField was expected to be the first full-service, FDIC-insured bank to offer both traditional banking and bitcoin.
Fintechs and investor groups are becoming more attractive M&A partners for community banks as the number of charters continues to shrink and economic concerns limit traditional bank M&A, said Joseph Ceithaml, capital markets and M&A leader for the Financial Institutions Group at Chicago-based law firm Barack Ferrazzano.
The continued growth of technology in banking comes as regulators continue to identify the risks posed by AI. The technology reportedly poses risks both through third-parties and to cybersecurity and consumer protection. The technology can also pose bias and discrimination-related challenges if improperly trained or used with data sets that use data that perpetuates past bias.
A Dec. 7 semiannual risk report from the Office of the Comptroller of the Currency identified both the risks and benefits of AI. “It is important that banks manage AI use in a safe, sound and fair manner, commensurate with the mentality and complexity of the particular risk of the activity or business processes supported by AI usage,” according to the OCC.
CFPB Director Rohit Chopra identified the risks he sees arising from AI in recent testimony before the Senate Banking Committee and House Financial Services Committee. Chopra said AI-fueled misconduct could be “dramatically magnified” if firms depend on the same foundational model or if a fraudster successfully mimics human connection.
“This may not be an accident,” he noted. “This may actually be a purposeful way to disrupt the U.S. financial system and we should look at it with that mindset.”
To prevent AI from harming the financial system, Chopra said regulators must ensure that providers are held responsible for data breaches if they fail to implement sufficient safeguards. “Where there is extremely opaque AI, that magnifies disruptions in a market that turns tremors into earthquakes,” he added.
5. M&A DOWN AMID ECONOMIC WOES
Bank M&A was significantly down in 2023 due to rising interest rates and fears of a recession.
According to S&P Global, the 91 bank M&A deals announced through the first 11 months of the year had an aggregate deal value of $3.95 billion, compared to $8.24 billion from the 144 deals announced over the same time in 2022.
As of early December, fourth quarter-to-date total deal value of $585.6 million represented a 79 percent drop from $2.76 billion in the third quarter, but was still higher than $432.8 million and $175.9 million in the first and second quarters, respectively.
Only five bank deals were reported in November, worth a combined $141.3 million, according to S&P Global. Two of those included banks headquartered in the Midwest. In one, Terre Haute, Ind.-based First Financial Corp. announced its acquisition of Dayton, Tenn.-based Simply Bank for $73.4 million. Also, Champaign, Ill.-based First Busey Corp. announced its expansion in the Chicago area by acquiring Channahon, Ill.-based Merchants and Manufacturers Bank Corp. for $42.3 million.
According to S&P Global, the Midwest’s 39 target banks account for 43 percent of M&A transactions announced in 2023 and nearly double the 20 target banks in the Southeast. Banks in the West had 15 targets.
In May, Bob Wray of Mission Hills, Kan.-based CC Capital Advisors said M&A had cooled as banks waited for large unrealized losses in their bond portfolios to recover. Wray, managing director of the company’s Financial Institutions Group, expected that more sellers would emerge later in the year as bond prices recovered amid reduced interest rates and shortened bond durations, with full recovery in the M&A sector likely by the spring of 2024.
Regulatory delays have also played a role in the slowdown of M&A. In May, Toronto-Dominion Bank’s planned $13.67 billion acquisition of Memphis, Tenn.-based First Horizon Corp., was called off, which was the largest U.S. bank deal termination on record.
Despite the number of bank charters falling to under 5,000 from 18,000 in 1985, Barack Ferrazzano’s Ceithaml expects the number to continue to fall as banks look to sell due to a lack of capital or increasing regulatory pressures.