Looking back and ahead as calendar turns

When banking industry historians look back on 2023, they will undoubtedly remember the trio of bank failures: Silicon Valley Bank on March 10, Signature Bank on March 12 and First Republic Bank on May 1. These failures said little about the condition of the broader banking industry and virtually nothing about the condition of banks in the Upper Midwest. These banks found trouble that most banks in the Midwest avoid: Unique lending concentrations, focus on crypto assets, profound asset-liability mismanagement, and undue dependence on uninsured deposits. 

Because of the size of these failures (SVB had $167 billion in assets, Signature $110 billion and First Republic $229 billion), they generated a lot of discussion about the need for deposit insurance reform, better regulatory supervision, and the significance of asset/liability management in a rising interest rate environment. Total assets of the three failed banks was much more than the total assets of the 25 banks that failed in the crisis year, 2008 ($374 billion).

There were two other bank failures in 2023 that caught the attention of BankBeat: The $139 million Heartland Tri-State Bank in Elkhart, Kan., failed on July 28, and the $66 million Citizens Bank, Sac City, Iowa failed on Nov. 3. Heartland Tri-State Bank’s failure was sudden, and one news outlet reported the bank’s troubles related to a massive crypto scam that ensnared the bank’s leadership.

Banks throughout 2023 dealt with a substantial change in interest rates. The Fed Funds rate increased from basically 0 in March of 2022 to 5.33 percent in July 2023. That change, married to an inverted yield curve the whole time, drove many other stories, such as difficulty attracting and retaining deposits, shrinking net interest margin and generally lower profits, the virtual collapse of the mortgage market, and a much-diminished pace of M&A transactions. The positive in all this is that asset quality stayed pretty good throughout the year.

Although, looking ahead through 2024, analysts worry about commercial real estate loans. Observers have been talking since the pandemic that with more people working from home, businesses are likely to reduce their office leases. That means more space to rent at a time when companies need less space. Obviously, this is a problem for building valuations and may make it difficult for landlords to stay current on their property loans.

But where there may be trouble with commercial real estate, things look good for multifamily housing. The rental market will remain hot as long as the market for new houses remains slow. New construction lending will still require diligence, but established apartment buildings should remain solid collateral for new loans.

It seems as though interest rates have peaked and that we may even see short term rates come down by mid-year or sometime in the latter half of 2024. This development may bring a lot of fresh life to the lending market, as well as break up the doldrums in the bank M&A arena. There were 79 bank M&A deals in the first three quarters of 2023, compared to 122 during the same period a year prior. The year 2022 closed with a total of 164 deals.  

Technology will only grow more important for service delivery. While banks will still need core processors, more services will be delivered via add-ons and non-core tech partners. Customers will increasingly expect to be able to make payments and conduct other financial transactions via their cellphone. FedNow became reality last July and its use will grow, particularly among commercial accounts. 

Next year is also likely to see an increase in M&A activity, which means, sadly, additional industry concentration. (We are down to 4,614 banks and savings banks in the country.) Most of the activity will be on the smaller end of the asset spectrum, where the costs of keeping up with technology and compliance obligations make it difficult to stay in business. The average bank will get bigger as the number of banks gets smaller. Credit unions will become more prevalent as bank buyers. 

Americans will elect a president in November. Contentious campaigning will fill our news, and everyone will be tired of political TV ads by this fall. I have no prediction about the outcome of the election, only a lot of hope that things don’t get worse.